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July 2019
KYRGYZ REPUBLIC INCLUSIVE GROWTH DIAGNOSTIC
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DIAGNOSTIC KYRGYZ REPUBLIC INCLUSIVE GROWTH DIAGNOSTIC
USAID Inclusive Growth Diagnostic Team – Kyrgyz Republic
Mark Gellerson Nathan Martinez Paul Oliver Joseph Spanjers
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TABLE OF CONTENTS
EXECUTIVE SUMMARY .......................................................................................................... vii
ACKNOWLEDGEMENTS ...................................................................................................... xiii
OVERVIEW & SYNDROME ............................................................................................... 14
OVERVIEW ................................................................................................................... 14
Purpose and motivation ........................................................................................... 14
Methodology ............................................................................................................ 14
Scope and limitations of the analysis ...................................................................... 17
Challenges ............................................................................................................... 18
SYNDROME: The Incomplete Transition to Democratic Governance ......................... 18
Recent Growth Experience ..................................................................................................... 20
Economic Growth, 1991-2017 ........................................................................................ 20
Growth Decomposition ................................................................................................... 22
Private Investment .......................................................................................................... 24
Capital Inflows ................................................................................................................ 26
International Trade .......................................................................................................... 27
Labor Market Dynamics ................................................................................................. 29
Poverty and Inequality .................................................................................................... 31
Conclusion ...................................................................................................................... 33
ACCESS TO FINANCE ........................................................................................................ 34
Financial Sector Structure ............................................................................................... 34
Is Finance a Binding Constraint ...................................................................................... 38
Is the shadow price of capital high? ........................................................................ 38
Do changes in access to finance impact private investment? .................................. 40
Are economic agents trying to bypass any constraints on access to finance? ......... 41
Conclusion ...................................................................................................................... 43
4 Microeconomic Risks ............................................................................................................. 45
4.1 Introduction ..................................................................................................................... 45
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4.2 Global Performance on Microeconomic Indexes & Indicators ...................................... 46
4.3 Microeconomic Issues in the Kyrgyz Republic .............................................................. 50
Regulatory Quality .................................................................................................. 50
The Gap between De Jure Design and De Facto Implementation ........................... 53
Political Stability and Rule of Law .......................................................................... 56
Corruption ................................................................................................................ 60
Taxes ........................................................................................................................ 62
Customs and Trade Regulation ................................................................................ 65
4.4 Conclusion ...................................................................................................................... 67
MACROECONOMICS .......................................................................................................... 68
Macroeconomic Stability in Kyrgyz Republic: Overview .............................................. 68
Macroeconomic Challenges ............................................................................................ 69
Growth and Inflation Volatility ............................................................................... 69
Fiscal Policy ............................................................................................................ 71
Exchange Rate ......................................................................................................... 72
4. Government Debt ................................................................................................ 74
4. Diversifying the Economy ................................................................................... 76
Conclusion ...................................................................................................................... 76
Market Failures ...................................................................................................................... 77
Introduction ..................................................................................................................... 77
Economic Diversification ............................................................................................... 78
Product Space Analysis ........................................................................................... 78
Index of Export Market Penetration ........................................................................ 81
Information Externalities ................................................................................................ 83
Summary ......................................................................................................................... 85
Human Capital ........................................................................................................................ 86
Summary ......................................................................................................................... 86
Access to Education ........................................................................................................ 87
Schooling, Enrollment, and Educational Attainment ..................................................... 88
Concerns About the Quality of Education ...................................................................... 89
Education and Gender ..................................................................................................... 90
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Enrolled students by stage (basic, secondary, tertiary) over time ................................... 91
Tertiary and TVET Education ........................................................................................ 92
Economic Returns to Education ...................................................................................... 93
Employment Outcomes by Education Level .................................................................. 94
Education Level of Migrants ....................................................................................... 95
Stakeholder Perceptions .............................................................................................. 97
Health .......................................................................................................................... 98
Conclusions ............................................................................................................... 100
Infrastructure ........................................................................................................................ 101
Introduction ................................................................................................................... 101
Electricity ...................................................................................................................... 102
Sector Overview .................................................................................................... 102
Shadow Price of Electricity ................................................................................... 103
Impulse Response of Electricity and Economic Growth ....................................... 104
Circumvention and Electricity ............................................................................... 105
Electricity and Profits by Sector (Camels and Hippos) ......................................... 105
Transport ....................................................................................................................... 106
Sector Overview .................................................................................................... 106
Shadow Price of Transport .................................................................................... 109
Impulse Response of Transport Infrastructure and Trade ..................................... 110
Circumvention and Transport Infrastructure ......................................................... 111
Transport Costs for Non-Exporters and Exporters ................................................ 112
Ports .............................................................................................................................. 113
Summary of Findings ............................................................................................ 113
Information and Communications Technology ............................................................ 115
Overview and Summary of Findings ..................................................................... 115
Water ............................................................................................................................. 116
Overview and Summary of Findings ..................................................................... 116
Conclusion .................................................................................................................... 117
Natural Capital ..................................................................................................................... 118
Agricultural Land Resources ........................................................................................ 118
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Mineral & Natural Resource Wealth ............................................................................ 119
Water Resources ........................................................................................................... 120
Biodiversity ................................................................................................................... 121
Climate Change and Environmental Risk ..................................................................... 122
Distance to Markets ...................................................................................................... 122
Conclusion .................................................................................................................... 123
References Cited .......................................................................................................................... 124
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LIST OF ABBREVIATIONS
ARM Armenia MDA Moldova CAREC Central Asia Regional Economic
Cooperation MSME Micro, small, and medium enterprises
DISCO Distribution company MW Megawatt DTF Distance-to-frontier NGO Non-governmental organization EBRD European Bank for Reconstruction and
Development NPL Nepal
ECA Europe and Central Asia OECD Organization for Economic Cooperation and Development
EIB European Investment Bank PPA Power purchase agreement ETF European Transportation Foundation PSA Power sales agreement FDI Foreign direct investment R&D Research and development GCI Global Competitiveness Index TJK Tajikistan GDP Gross domestic product UNCTAD United Nations Conference on Trade and
Development GEO Georgia UNESCO United Nations Educational, Scientific, and
Cultural Organization GITR Global Information Technology Report USAID United States Agency for International
Development GNI Gross national income USD United States dollar HRV Hausmann, Rodrik, and Velasco VAT Value-added tax ICT Information and Communication Technology WSS Water Supply and Sanitation IGD Inclusive Growth Diagnostic WDI World Development Indicators ILO International Labor Organization WGI World Governance Indicators ITU International Telecommunications Union WHO World Health Organization IMF International Monetary Fund WRI The World Resources Institute JSC Joint Stock Company WTO World Trade Organization LAO Laos
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EXECUTIVE SUMMARY
Background Since its independence in 1991, the Kyrgyz Republic has undergone a long period of economic and political transformation with occasional political unrest, including violent revolutions in 2005 and 2010. Today the Kyrgyz Republic is a lower-middle income country that Freedom House describes as a “partly free” state, an indication that the country has achieved some success in democratic transition but has yet to develop stable and fully transparent democratic institutions that are responsive to its citizens and free of corruption. While the Kyrgyz Republic has been more successful that its Central Asian neighbors in its transition toward democratic governance, many opportunities exist to improve the effectiveness of government institutions and better guide the economy along a long-term economic development path. Though it lacks the oil and gas reserves of the neighboring states to the west and north, the Kyrgyz Republic has extensive natural resources in the form of mining and hydropower that have been underdeveloped due to problems with governance and corruption that deterred the foreign investment necessary to develop these resources. The agriculture sector is limited by low productivity, and the services sector is constrained by low levels of human capital. The development of a robust and dynamic private sector will be necessary for the country to realize its economic growth potential and stated economic objectives. USAID can assist the government in its journey to self-reliance, and the Agency’s new private sector engagement policy provides an opportunity to work with partners in new and innovate ways. The findings from this inclusive growth diagnostic (IGD) will assist the Mission as it plans future strategies and programs that are consistent with private sector-oriented growth and a focus on the principles of self-reliance. Methodology The foundational assumption of the IGD methodology is that private sector investment and entrepreneurship are critical for sustained and inclusive economic growth. Furthermore, to support that investment, the private sector needs: (1) access to finance at a reasonable cost and (2) an expectation that they will receive a reasonable return on their investment, both of which are further unpacked and examined in the form of a diagnostic tree (Figure 0.1). Using this tree, the IGD runs a series of data driven tests (see Chapter 1) to arrive at evidence-based conclusions regarding the bottlenecks to growth.
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Figure 0.1 Inclusive Growth Diagnostic Framework (‘Tree’)
Source: Hausmann, Rodrik, and Velasco 2005 Limitations of the Report The IGD methodology utilizes existing data to examine where binding constraints to growth currently exist. As such, it is not intended to assess alternative possibilities that may exist in the future but do not exist today. Therefore, while the findings in this report point to valid and critical problems that currently exist in the Kyrgyz economy, these findings may not hold if major economic and political shocks occur, such as a political revolution or major financial crisis. Furthermore, the IGD methodology does not prioritize results based on political feasibility or objectives other than private sector economic growth and makes no recommendations on whether or to what extent such other factors should be considered in formulating final programming decisions. Findings The analysis identifies both primary and secondary bottlenecks to growth heretofore referred to as binding constraints and secondary constraints/emerging issues. More specifically, a constraint represents a factor that is keeping the economy from growing. Although it can be tempting to think of all problems in the economy as binding constraints, the IGD methodology takes as its starting assumption that constraints are binding to varying degrees. In other words, while a number of issues may be relevant for economic growth, it is still possible to rank order these
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according to “Which one, if relaxed, will deliver the biggest bang for the effort.”1 The purpose of the IGD methodology, therefore, is to use rigorous analysis and a strict methodological framework to help identify the most important (or binding) constraints to a country’s growth.
Binding Constraint
Microeconomic Risks
The results of this IGD show the binding constraint to economic growth in the Kyrgyz Republic is weak economic governance related to the uncertain application of the law. Although the legal and regulatory quality is well designed in many cases, the implementation of the law is often very poor and inconsistently applied. Firms and entrepreneurs lack confidence that the rules and regulations in place will be enforced properly, particularly in the long term. A poorly performing judicial system undermines the rule of law and creates challenges to contract enforcement, legal protections, and property rights. The uncertain regulatory environment increases business risk, which increases the cost of doing business and deters investment from both domestic and international sources.
Many private sector business people and economic experts expressed frustration with the fickle nature of the economic rule of law. These sentiments are supported by a wide variety of data sources that measure legal and regulatory structures and the institutions that oversee them. For example, the Kyrgyz Republic scores relatively well on the Fraser Institute Economic Freedom Index, but the sub-indicator for the legal system and property rights is very low relative to other countries. The Kyrgyz Republic scores relatively well on many measures of the business environment as measured in the World Bank’s Doing Business report, which measures time to comply with formal procedures, but scores very poorly in the World Bank’s Enterprise Surveys when firms are surveyed about their actual experiences.
Overall, the IGD team found convincing evidence that microeconomic risks are the binding constraint to growth. There are four main pieces of evidence:
1) The legal and regulatory cost of business is very high. 2) There is a strong negative correlation between political instability, which results in changes to regulatory and judicial enforcement, and economic growth rates. 3) Firms bypass regulatory constraints through corruption and operations in the informal sector. 4) Investment is low in industries that remain underdeveloped and would require substantial foreign direct investment (FDI), particularly in mining and hydropower.
1 Doing Growth Diagnostics in Practice: A ‘Mind Book,’ Ricardo Hausmann, Bailey Klinger, Rodrigo Wagner, CID Working Paper No. 177, September 2008.
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Secondary Constraints and Emerging Issues
Human Capital
The quality of the education system is a secondary, or emerging, constraint. Despite a healthy level of government spending on education (7.2% of GDP and 18.5% of government expenditures), the social return from this investment in human capital is low. Almost all students complete secondary education, and literacy rates are above 99% for both men and women. The average citizen has 10.7 years of education, which is high by international standards, yet the Kyrgyz Republic remains a lower-middle income country, international test scores are extremely low, and firms are constrained by the inability to find skilled workers. To bypass the human capital constraints, the private sector invests heavily in training its own workers, much more so than other countries.
Despite the dire situation with education quality, human capital does not rise to a binding constraint because there is mixed evidence from the IGD analysis. Surprisingly, there is no financial return to higher education. On average, workers with higher level education do not receive higher wages than workers with lower education, which is extremely unusual, and further speaks to the quality issues in the education system. In addition, the unemployment rate for tertiary education workers is not lower than those with secondary education. These facts suggest that the economy is not constrained by a shortage of higher educated workers.
Access to Finance
Access to finance is also a secondary, or emerging, constraint. While not as binding and immediately urgent as the microeconomic constraints described above, a small and conservative financial sector is insufficient to meet the demands for private sector growth in the longer term. Without a stronger financial sector, the economy will continue to operate below potential. Evidence for the constraint lies in the high cost of finance charged to borrowers (particularly for som-denominated loans) and the low level of domestic credit to the private sector. However, the evidence is mixed since relatively few firms of any size cite access to finance as a top obstacle to doing business. The supply of credit does not seem to be an issue; the constraint lies more in the low demand for credit. Finance appears to be most constraining for small and medium firms and firms operating in rural areas outside of the urban commercial centers. This raises concerns about the inclusivity of finance.
Conservative banking regulation is partly responsible for high lending rates available from the commercial banks. More notably, banks face high risks, and therefore costs, which contribute to the high interest rates and conservative lending patterns across the sector. Due to high dollarization in the economy along with perceived som currency risks, about half of all lending is in US dollars, and these loans offer lending interest rates that are about 8-10 percent lower than som. The banking sector remains small and dominated by traditional commercial banks that
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account for 90% of all credit, and bank deposits and bank loans to the private sector remain relatively low.
Other Notable Findings
Infrastructure did not rise to the level of a binding or secondary constraint, but notable limitations exist in certain areas of infrastructure. Domestic transport infrastructure is a challenge, particularly roads. There is overall low road density and many local roads are of poor quality. However, the evidence that roads and transport infrastructure are a constraint is mixed because many delays result from regulatory issues related to border and compliance requirements and not the physical infrastructure itself.
Electricity is also a concern due to inadequate maintenance and low generation capacity that results, in part, from underinvestment and underutilization of the country’s hydropower resources. However, the root cause of the electricity constraint is the below-recovery tariff structure that provides the government with insufficient revenue to maintain the existing infrastructure, let alone invest or induce investment in new capacity. In other words, the electricity sector’s problems are directly related to the poor governance and administration issues described in the chapter on microeconomic risks.
The IGD team did not find evidence of a binding constraint in macroeconomic risks, natural capital, or market failures.
Conclusions
This inclusive growth diagnostic finds that the binding constraint to economic growth in the Kyrgyz Republic is weak economic governance related to the uncertain application of the law. High political turnover and a weak rule of law create an unpredictable business environment that increases the risk and cost of doing business and thus deters firm growth and new investment. The inconsistent and unreliable application of economic laws and regulations creates an uncertain business environment in which firms lack confidence in contract enforcement, tax administration, judicial interpretation, and other legal and regulatory issues that affect the cost of doing business. These issues are particularly problematic for long-term investments.
Secondary constraints are found in the poor quality of the education system and access to finance. The Kyrgyz Republic invests heavily in the education system but does not benefit from the return to that investment. Improvements in education quality will be necessary for long-term growth as the country develops more modern and human capital-intensive industries. Finance remains expensive, and borrowing is limited. The development of a more inclusive and competitive financial sector will be necessary for the economy to reach its potential.
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Figure 0.2 Summary of Diagnostic Tests in the Kyrgyz Republic TESTS
Shadow Price
Impulse-
Reaction
Circum
vention
Cam
els &
Hippos IMPLICATIONS
BINDING CONSTRAIN
T
Microeconomic Risks
Prioritize governance and judicial reforms to improve the predictability and fairness of legal enforcement so as to provide firms and investors with long-term confidence in the business environment.
SECONDARY &
EMERGING CONSTRAIN
TS
Human Capital
Prioritize improvements in the quality of the education system so that students are equipped with soft and hard skills the private sector demands.
Finance
Prioritize reforms in financial sector law and regulation that create a more competitive, affordable, and inclusive financial system.
NOT YET BINDING
Infrastructure Macroeconomic Market Failures Natural Capital
Key Test suggests constraint is significant. Test suggests constraint is not significant. Unable to conduct test, or test was inconclusive.
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ACKNOWLEDGEMENTS
The members of the Inclusive Growth Diagnostic Team would like to thank the numerous people and institutions who lent their time and expertise to this project. We could not have completed this work without the generous contributions of colleagues from the Kyrgyz Republic and Washington, DC.
We especially want to thank the many Kyrgyz experts who generously donated their time to speak with the IGD team during the in-country research phase of this project. We thank the many government officials and staff members of think tanks, private businesses, industry groups, and international organizations who took time from their schedules to share their knowledge, experience, and insights.
We also want to thank the many local and American staff at the USAID Mission in Bishkek who provided professional expertise, logistical support, and translation. We particularly thank Paul Hamlin, Chnara Mamatova, Aisha Abdugalyeva, Gary Shu, Zeinep Isakova, and Mukhtar Irisov.
The authors of this report take full responsibility for any and all errors and omissions. The views expressed in these pages are those of the authors and not necessarily those of USAID, USAID Kyrgyz Republic, the Department of State, the U.S. Embassy in the Kyrgyz Republic, or the United States Government.
--- MG, NM, PO, JS
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OVERVIEW & SYNDROME
OVERVIEW
Purpose and Motivation
The purpose of the Kyrgyz Republic Inclusive Growth Diagnostic is to diagnose the most binding constraints to economic growth. The goal of this report is to inform the programming and decision-making for the USAID Kyrgyz Republic Mission.
Methodology
The growth diagnostic methodology was first described by Ricardo Hausmann, Dani Rodrik, and Andres Velasco (HRV) in 2005.2 Hausmann, Bailey Klinger, and Rodrigo Wagner wrote the ‘Mindbook’ operationalizing the HRV methodology in 2008.3
“The foundational assumption of this methodology is that private sector investment and entrepreneurship are necessary for sustained economic growth. From this assumption, the methodology proposes two possible explanations for low levels of private investment and entrepreneurship: the expected private returns to investments are too low, or the cost of financing is too high. Under the first explanation, there is sufficient supply of financing for private sector investment to flourish but the demand for financing is too low because there are no profitable investments available to entrepreneurs. This can result from low social (economic) returns or low appropriability, which refers to the expectation that any profit from an investment will be ‘appropriated’ away for some reason. Under the second explanation, the cost of financing can be traced to either international financial markets or domestic financial markets.”
The authors of the methodology created an organizing framework, seen in Figure 0.1, to illustrate their argument. The chapters in this report broadly follow the divisions of this framework, or ‘tree.’
To operationalize the ‘tree,’ the authors offer four “principles of differential diagnosis” for identifying constraints to growth (Table 1.1).
2 Hausmann, Ricardo; Rodrik, Dani and Velasco, Andrés. “Growth Diagnostics.” Harvard University, 2005. 3 Hausmann, Ricardo; Klinger, Bailey and Wagner, Rodrigo. “Doing Growth Diagnostics in Practice: A ‘Mindbook.’” Center for International Development, Harvard University, Working Paper No. 177, 2008.
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Table 1.1 Principles of Differential Diagnosis Principle Explanation Example
The shadow price of the constraint should be high.
The shadow price indicates whether the opportunity cost or value to a consumer is greater than the market price.
A price ceiling on gasoline creates a black market in which consumers pay a higher price.
Movements in the constraint should produce significant movements in the objective function.
When the constraint is relaxed, there is a positive market reaction (investment and entrepreneurship increase). Referred to as the impulse-response test.
Reducing tax rates results in an increase in investment when tax rates are a constraint.
Agents in the economy should be attempting to overcome or bypass the constraint.
Economic actors should be taking observable steps to circumvent the constraint. Referred to as the circumvention test.
Firms purchase generators instead of relying only on the grid when electricity is a constraint.
Agents less intensive in the constraint should be more likely to thrive, and vice versa.
Firms should flourish if they are better-suited to the domestic business environment. Referred to as the “camels and hippos” test.
Firms that are less dependent on infrastructure (e.g. electricity) fare better when infrastructure is a constraint.
Source: Ricardo, Klinger, and Wagner 2008 No single principle or test is sufficient to declare a given constraint to be the most binding for economic growth. Instead, the methodology requires conducting multiple tests across each ‘node’ of the framework and aggregating these tests to make the most credible conclusion. Table 1.2 illustrates how the nodes are connected to specific sectors and conclusions.
Table 1.2 IGD Nodes, Relevant Sectors, and Relevant Implications Node Sectors / Issues Negative Implications
Low Social Returns
Infrastructure (Bad infrastructure)
Water, telecommunications, energy, roads, ports, etc.
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Human Capital (Low Human Capital)
Education, health system, labor market, etc.
Poor inputs to production leading to low returns on investment
Low Appropriability
Government Failures
Microeconomic Risks
(Enabling Environment)
Property rights, court system, regulation, corruption, firm-level tax policy, etc.
Inability to reap an adequate return on one’s investment
Macroeconomic Risks
(Enabling Environment)
Monetary policy, exchange rate policy, fiscal management, inflation, etc.
High uncertainty of potential return to investment
Market Failures
Coordination Failures Market efficiency (e.g., availability of information on supply and demand)
Missed opportunities for maximizing profits
Information Externalities Intellectual property rights legislation, patent laws, prevalence of R&D
Slow adaptation of technologies lowering profitable returns to investors
High Cost of Finance
Availability of Finance (Low domestic savings and poor international finance)
Foreign Direct Investment (FDI), financial institution access, financial market depth
Lack of access to finance
Cost of Finance
(Poor local Finance)
Financial market regulations, overhead costs, investment risk, collateral policies
Finance is available but too expensive to ensure a profitable return to investment
Source: Modified from South Sudan Growth Diagnostic Scoping Mission. USAID, 2013.
Comparator Selection
To apply the principles of differential diagnosis, we must benchmark the country of interest against other comparable countries, or “comparators.” Following the USAID guidelines for conducting an IGD, the IGD team employed a variety of criteria for selecting comparators, including the indicators in Table 1.3, among others, as well as historical, political, and geographic considerations. Based on these criteria, we selected the following comparator countries: Armenia, Georgia, Lao PDR, Moldova, Nepal, and Tajikistan. Important considerations for comparator selection included the Kyrgyz Republic’s geographic features,
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particularly the fact that it is a small, landlocked, mountainous country, and the important historical considerations that arise as a former republic of the Soviet Union. Armenia and Georgia were included as more “aspirational” comparators because they have higher GDP per capita but matched well on other variables. Lao PDR was included because of its close match on many key variables, and it provided some geographic and historical diversity by being outside of the former Soviet bloc. The team intentionally excluded upper-middle income countries dependent on oil and natural gas production. Occasionally, special comparator selections are used to run certain tests; these are described in sources or footnotes as needed.
Table 1.3 Selected Criteria for Comparators Data are 5-year averages, 2011-2015
GDP per capita (constant 2010 US$)
GDP per capita growth (annual %)
GDP per capita, PPP (constant 2011 $)
Total natural resources rents (% of GDP)
Kyrgyz Republic 1,025 3.5 3,249 8.1 Armenia 3,925 3.2 8,175 4.2 Georgia 3,972 3.7 9,023 1.0 Lao PDR 1,557 5.9 5,756 10.5 Moldova 2,020 4.6 4,841 0.3 Nepal 686 3.2 2,300 1.1 Tajikistan 932 4.6 2,660 3.2
Source: World Bank WDI
Scope and Limitations of the Analysis
While the IGD methodology can lead to significant and valuable insights that inform better decision-making, we want to make its limitations clear. Most importantly, this report will not prescribe specific interventions in response to our diagnosis of the most binding constraints to growth. In the same way that diagnosis and treatment of a disease are separate medical functions, we leave the ultimate ‘treatment’ of the binding constraints to others and hope that our analysis informs their decisions.
This limitation has three important implications. First, our analysis does not account formally for current reforms or initiatives that may impact economic growth. This stems from our reliance on data, which has not yet been collected on events still in motion. Second, our analysis does not attempt to incorporate political economy considerations. That is, it identifies key constraints to growth in the Kyrgyz Republic without assessing the political or practical feasibility of reform efforts targeting these constraints. Third, our analysis does not account for the cost-effectiveness of interventions. Beyond the potential political constraints to intervention, there may also be financial or economic constraints that limit the feasibility of action.
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Further research, such as a political economy analysis of reform options for the Kyrgyz Republic, or cost-benefit analysis at the project level, would provide a more comprehensive understanding of the types of interventions that would be both feasible and impactful.
Challenges
Data availability
Data availability is generally good for the Kyrgyz Republic, and government ministries and the National Statistical Committee of the Kyrgyz Republic provide a wide variety of data sources on key topics related to the IGD methodology. Regional disaggregation was often available. Most major international indicators provided by the World Bank, IMF, and other organizations were available for the Kyrgyz Republic and the comparators, which increased the robustness of the analysis and the number of tests that could be run. However, there were several areas of concern in data availability, particularly related to access to current data. One major area of data concern results from the lack of recent participation in international education tests, which is necessary to assess whether or not the government has been successful in improving education quality. Further, a more recent Enterprise Survey would have given a better sense of the key challenges that businesses in the Kyrgyz Republic currently face, though interviews conducted for this IGD uncovered issues that largely aligned with the challenges cited in the 2013 survey. Finally, more data disaggregation by youth and gender would have enhanced the inclusivity aspects of the analysis.
SYNDROME: The Incomplete Transition to Democratic Governance
The HRV growth diagnostic methodology recommends that the team identify a ‘syndrome’ that links the identified ‘symptoms,’ or constraints to growth. The syndrome in the Kyrgyz Republic is the incomplete transition to democratic governance. In other words, the country has been moderately successful at developing a democratic system with many peaceful transitions of power, but two revolutions since 2005, high political turnover, and corruption still plague the government and society. Freedom House identifies the country as “partly free.”
The incomplete transition to democratic governance is the underlying characteristic of the economy that connects all of the constraints identified in this IGD. It is not the constraint itself but rather the source of the constraint. In the Kyrgyz Republic, the inability to develop a fully democratic system of government has allowed for the development and continued existence of weak institutions that prevent fair and effective regulation of a free market economy.
It is important to remember that private sector firms are not directly impacted by changes in political power or democratic transformation. Instead, firms make decisions based on costs, risks, and opportunities to grow their businesses and maximize profits. Sometimes political issues affect firm-level decision making, but it is not necessarily so. The benefit of the IGD
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methodology is that it provides a rigorous framework to evaluate the precise mechanism by which the underlying syndrome affects private sector business and investment decisions.
From Syndrome to Constraint
The syndrome manifests itself in the form of economic constraints in every branch of the IGD diagnostic tree. In finance, political change and uncertainty increases the risk to banks, so banks have to increase interest rates to compensate for that risk. Macroeconomic conditions can change rapidly if there is a revolution or other unexpected political shock. Human capital suffers from ineffective educational institutions and low accountability to hold leaders responsible for educational outcomes. Infrastructure is underdeveloped and poorly maintained because of ineffective policies such as energy tariffs priced below cost recovery. And of course, the incomplete transition to democratic governance weakens the political institutions that are necessary to create a strong rule of law and certainty in the business enabling environment.
The remaining chapters of this IGD provide a detailed assessment of each of the nodes on the diagnostic tree to determine what is and is not a binding constraint to private sector economic growth.
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RECENT GROWTH EXPERIENCE Key Messages
• Economic growth has fluctuated, with economic contractions following political revolutions in 2005 and 2010.
• There has been significant progress in poverty reduction since 2000 thanks to massive growth in remittances, which are now equal to roughly one-third of GDP.
• However, reductions to poverty and inequality have stagnated since 2009.
This chapter provides an overview of the economic growth experience in the Kyrgyz Republic since its independence from the Soviet Union in 1991. Beginning with a brief discussion of the broad economic trends for the Kyrgyz Republic over this period, the chapter includes a basic growth decomposition as well as data on private investment, capital inflows, trade, the labor market, and poverty and inequality. Throughout, the data is presented with country comparators to give additional context.
Economic Growth, 1991-2017 Economic growth enables countries to reduce extreme poverty and provides a necessary condition for shared, inclusive prosperity. A mountainous, landlocked country, the Kyrgyz Republic is today the second-poorest country in Central Asia. Despite the country’s long history, the modern nation-state was not formed until August 31, 1991, when the Kyrgyz Republic gained independence from the Soviet Union. Like many other post-Soviet states adjusting to their new reality, the country went through a drastic depression in the immediate aftermath of its independence.
Figure 2.1. GDP Per Capita (percent Annual Growth)
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Since the economic contraction in the early 1990s, the country has followed a fluctuating growth path Figure 2.1). Political and economic reforms in the mid-90s (land privatization, de jure business enabling environment, trade liberalization, etc.) set the stage for potential growth thereafter. There has been significant progress in poverty reduction since 2000 thanks to massive growth in remittances, with resulting consumption-driven growth. But poverty reduction has largely stagnated since 2009. Further, political unrest has been a regular feature of life in the Kyrgyz Republic: in March 2005 and April 2010, street protests led to the ouster of President Askar Akayev and President Kurmanbek Bakiyev, respectively. The economy suffered from negative growth in both of these years (see vertical lines above). Following the second revolution, the country amended its constitution to transition from a democratic republic with a strong presidency to become the only parliamentary democracy in Central Asia.4 Since 2014, growth has stabilized, though on a lower trajectory (Table 2.1).
Table 2.1. Average Annual Percentage Growth for Selected Periods
1991-1995 1996-2004 2005-2017
GDP per capita -13.2 4.0 2.7
GDP -12.5 5.3 4.3 Source: World Development Indicators Like the Kyrgyz Republic, Armenia, Georgia, and Tajikistan suffered deep recessions in the immediate aftermath of the Soviet Union’s breakup. Though data for Moldova is not available for that time, it has followed a similar fluctuating growth path to the other four post-Soviet republics. Nepal and Laos have instead followed a relatively stable path, with consistent moderate growth in GDP per capita since the early 1990s. Relative to these comparators, the Kyrgyz Republic has rarely been among the fastest-growing in recent years (Figure 2.2). The rest of this chapter explores macroeconomic dynamics which can expose the underlying factors of this relatively slow growth.
4 Despite this transition, the presidency has effectively remained the most important political post in the country.
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Figure 2.2. GDP Per Capita (percent Annual Growth), Kyrgyz Republic and Comparators5
Growth Decomposition By disaggregating GDP by its components and by sector, it is possible to see the primary sources of growth in the economy as well as its structural transformation (Figure 2.3). The overall size of the Kyrgyz economy is largely dictated by household consumption, consistently the largest portion of gross domestic product by expenditure, though it has been on the decline since 2012. Government consumption, meanwhile, is today somewhat smaller as a percentage of GDP than at the time of independence. Investment, labeled here as gross capital formation, has crept up, though marginally.
5 KGZ = Kyrgyz Republic, ARM = Armenia, GEO = Georgia, LAO = Laos, MDA = Moldova, NPL = Nepal, TJK = Tajikistan.
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Figure 2.3. GDP Expenditure Components
The current account deficit, when the value of the goods and services imported exceeds the value of exports, has retreated from its nadir of roughly 50 percent of GDP over the 2012-2014 period. As the figure above clearly illustrates, however, net exports remain negative, with the external balance equal to a negative 31 percent of GDP in 2017. Though a negative external balance is not inherently problematic, it can be when imports are not directed toward productivity-improving investments. Unfortunately, this is the case in the Kyrgyz Republic, where the high demand for imports is driven by remittance-fueled household consumption.
The sectoral composition of the economy has changed dramatically since independence (Figure 2.4). In the immediate aftermath of the Soviet Union’s dissolution, manufacturing’s role in the Kyrgyz economy plummeted as historical supply chain linkages were severed. Dropping from roughly one third of the economy to under ten percent in just a few years, it never recovered its previous role and has since stabilized at around 15 percent of GDP. The other primary trend is the clear shift from agriculture to services, as increased remittances in the 2000s led many previously engaged in rural agriculture to instead participate in largely informal urban services.6 Though this shift in employment increased the economy’s productivity, the relatively low productivity of the service sector specifically and private sector generally has limited opportunities for future growth.7
6 Informality has an interesting dynamic in the Kyrgyz Republic. Though there are unregistered businesses, the term mainly refers to “patent holders,” or small entrepreneurs that pay a small, fixed monthly amount to the Kyrgyz government for the right to operate their business free from a number of regulations required of larger firms in the main tax regime. 7 World Bank Group, “Kyrgyz Republic: From Vulnerability to Prosperity, A Systematic Country Diagnostic,” 2018, p. 4.
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Figure 2.4. GDP by Sector (percent GDP)
Private Investment Private investment is essential for sustainable, self-reliant growth to occur. Relative to its comparators, the Kyrgyz Republic fared poorly in attracting domestic or international private investment through the mid-2000s. However, since then private investment has ticked up, with private gross capital formation, the net increase in physical assets, reaching 24 percent of GDP in 2014 (Figure 2.5). A similar story is true of overall gross capital formation, with the Kyrgyz Republic performing favorably relative to its comparators in the 2010s (Figure 2.6). A notable exception to this is the steep drop in both private and overall investment in 2010 and 2011, potentially related to the political turmoil of the second Kyrgyz revolution.
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Figure 2.6. Private Gross Capital Formation (percent GDP)
Foreign direct investment (FDI) in the Kyrgyz Republic has been exceedingly volatile relative to the country’s comparators (Figure 2.7). In a country where capital is relatively scarce, like the Kyrgyz Republic, FDI can be an essential driver of increased productivity, private sector growth, and high-quality job creation. However, as the chart below shows, foreign investors’ view of the Kyrgyz Republic as a desirable investment destination has clearly ebbed and flowed since independence.
Figure 2.5. Total Gross Capital Formation
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Figure 2.7 FDI Net Inflows (percent GDP)
Capital Inflows
In countries with low capital stocks, or not enough assets for production, capital inflows can spur economic development. Remittances are clearly the most important form of capital inflow for the Kyrgyz Republic,8 skyrocketing from less than one percent of GDP as recently as 2001 to equal nearly a third of the economy in 2017—making the Kyrgyz Republic the second-most remittance-dependent country in the world that year (Figure 2.8).9 However, as evidenced by the steep drop in 2015, this source of inflows is highly vulnerable to external shocks, in this case the economic turmoil in the Russian Federation during this period. Official development assistance (ODA) provides something of a buffer against the fluctuations evident in FDI and remittance flows, though it has dropped off as a percentage of GDP since its peak at 23 percent in 1999.
8 Most Kyrgyz migrants work in Russia’s construction and services sectors, as noted in the labor market section later in this chapter. 9 World Bank Group, World Development Indicators. Remittance inflows as a percentage of GDP, 2017. The most remittance-dependent country in 2017 was Tonga at 37.1 of GDP, followed by the Kyrgyz Republic at 32.9 percent, Haiti (32.4 percent), Tajikistan (31.3 percent), and Nepal (27.8 percent).
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Figure 2.8 Remittances, FDI and ODA (percent GDP)
International Trade
International trade allows countries to specialize in the products and industries they hold a comparative advantage in. Many of the most impressive development stories in recent decades have been the result of export-oriented growth. However, as a landlocked, mountainous country with an acute infrastructure deficit, this type of strategy has proved challenging for the Kyrgyz Republic in the years since independence.
Figure 2.9. External Trade, Exports and Imports (percent of GDP)
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At an aggregate level, the Kyrgyz Republic’s exports as a percentage of GDP are in the midrange relative to its comparators. Nonetheless, a highly diversified export base does not presently exist in the country. In 2017, 37 percent of the Kyrgyz Republic’s export earnings came from its sole gold mine,10 which is projected to cease extraction in 2023 and milling in 2026.11 Though the country has considerable mineral wealth, no replacement has yet been developed to replace foreign exchange earnings from the Kumtor gold mine. Other major exports include other mineral products (18 percent of the total), textiles (8 percent), transportation products (7 percent), vegetables (6 percent), as well as minor exports of other metals, machines, foodstuffs, and animal products.
Imports, meanwhile, are high relative to comparators. Imports are dominated by consumer products, with textiles, footwear, and headwear combining to account for 36 percent of imports in 2017. Other important imports included mineral products (12 percent of the total), machines (12 percent), chemical products (7 percent), metals (7 percent), and foodstuffs (6 percent). At nearly 67 percent of GDP in 2017, the Kyrgyz Republic has a higher import level than all comparators but Moldova. The high level of goods imports in the Kyrgyz Republic can only be sustained with remittance inflows. Both exports and imports are dominated by goods trade, though services exports have expanded since independence.
Figure 2.10. Goods and services external balance (percent GDP)
10 UN Comtrade. 11 Kumtor Gold Company, Production. https://www.kumtor.kg/en/about/faq/production/
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A diversified set of established export and import partners can reduce a country’s exposure to external shocks. The Kyrgyz Republic has a heavy reliance on several trading partners, highlighting the country’s vulnerability to events outside its control. In 2017, 58 percent of exports went to just three countries—Switzerland,12 Kazakhstan, and the Russian Federation—while 61 percent of imports were sourced from only two partners—China and the Russian Federation. This high concentration of trading partners is a source of political and economic risk.
Table 2.2. Top Kyrgyz Republic Export and Import Partners
Top Export Partners (2017) Top Import Partners (2017)
Country % Total Exports Country % Total Imports
Switzerland 27.8 China 33.3
Kazakhstan 15.1 Russian Federation 27.5
Russian Federation 15.1 Kazakhstan 11.6
United Kingdom 10.9 Turkey 5.0
Uzbekistan 8.3 Uzbekistan 3.6
Turkey 7.5 United States 3.5
China 5.5 Belarus 2.4
United Arab Emirates 1.7 Germany 1.5
Tajikistan 1.4 Korea, Republic of 1.0
Belgium 1.2 Ukraine 0.9
Source: UN Comtrade
Labor Market Dynamics Jobs are a crucial part of a country’s journey to self-reliance, as greater participation in the labor force can be spurred by the availability of high-quality jobs. They enable the productive use of
12 The high level of exports to Switzerland is due to its central role in the global gold trade.
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human capital and provide not only a source of income for a household, but also improve domestic resource mobilization through personal income taxes. Though the Kyrgyz Republic has only moderate unemployment, closer examination reveals that those Kyrgyz with jobs are largely in low-productivity sectors and that many have chosen to migrate abroad for work rather than participate in the domestic labor market.
Figure 2.11. Unemployment and Labor Force Figure 2.12. Youth Unemployment
The Kyrgyz Republic has moderate unemployment and labor force participation rates relative to its comparators (Figure 2.11) and does not appear to have disproportionately high youth unemployment (Figure 2.12). As of 2017, the unemployment rate in the Kyrgyz Republic stood at 7.3 percent. The same rate in comparator countries ranged from 0.7 percent in Laos to 18.2 percent in Armenia. The labor force participation rate stood at 65.2 percent, again between the lowest comparator rate of 47.1 percent in Moldova and 86.3 percent in Nepal. Youth unemployment similarly fell within the midrange of comparators, with 15.7 percent of 15-24-year-olds unemployed.
The majority of employment is centered on the domestic market in the services and agriculture sectors. Within the services sector, most employment is focused on wholesale and retail trade, education, transport and storage of goods, and hotels or restaurants.13 In lieu of disaggregated employment statistics for agriculture, production by value can be broken down into primary commodities: in 2018, provisional data shows that 29 percent of production value came from livestock and poultry, followed by 16 percent from raw milk, grains and legumes (14 percent), vegetables (12 percent) and potatoes (9 percent).14
13 National Statistical Committee of the Kyrgyz Republic, 1.07.00.03 Employed population by type of economic activity (NACE, 3) and territory. http://stat.kg/en/statistics/zanyatost/ 14 National Statistical Committee of the Kyrgyz Republic, 1.04.02.01 Gross output of agriculture, forestry and fishery products by categories of farms. http://stat.kg/en/statistics/selskoe-hozyajstvo/
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Since roughly 2000, the labor market in the Kyrgyz Republic has followed an atypical structural transformation. The movement of labor out of the agricultural sector was triggered by foreign employment alternatives and subsequent remittance-driven opportunities in the informal urban economy, rather than a more typical path to new, formal domestic jobs in emerging industries. These informal urban services jobs are only marginally more productive than rural agricultural jobs.15
Outward migration is a crucial feature of the Kyrgyz labor market, providing a clear release valve for a lackluster domestic job market.16 Though estimates vary for the migrant stock, approximately 800,000 Kyrgyz were working abroad as of July 2018, a staggering figure in a country with a population of 6.2 million, 3.5 million of whom are between ages 18-65. Of these migrants, 80 percent are working in the Russian Federation.17 Anecdotally, most of these workers are in the construction and services sectors (restaurants were commonly mentioned in interviews as employers, due to migrants’ good Russian language skills).
Poverty and Inequality The Kyrgyz Republic has achieved impressive reductions in poverty since 2000 driven largely by remittances. Using a poverty line of $1.90 a day (2011 PPP), the proportion of the Kyrgyz population in poverty declined from 42.0 percent in 2000 to 1.5 percent in 2017. Using a broader definition of poverty at $3.20 a day more applicable to lower middle-income countries, the percentage dropped from 77.6 to 19.6 over the same period. Over the same period, median monthly per capita income rose from $63.71 to $137.90 per month in 2011 PPP, indicating that incomes doubled over this period.18
Though this is undeniably a major achievement in poverty reduction, there are complicating factors. First, there has been little progress since 2009, when 21.0 percent of the population survived on less than $3.20 a day and median consumption was $141.09.19 Second, given that this poverty reduction is largely dependent on remittance income, it is susceptible to external shocks—an increase in the poverty headcount by 3 percent of the population was observed in 2015, the same year remittances plunged. Third, there is a significant level of precarity in the system, with large portions of the population at risk of slipping into poverty seasonally (this is partially evident from the low poverty gap measure, which implies that there is clustering around the poverty line). Fully 47 percent of the population experience at least one spell of poverty in the course of a year. This transient poverty implies a limited potential for households to expand
15 World Bank Group, “Kyrgyz Republic: From Vulnerability to Prosperity, A Systematic Country Diagnostic,” 2018, pp. 4, 8, 13. 16 World Bank Group, “Transitioning to Better Jobs in the Kyrgyz Republic: A Jobs Diagnostic.” September 18, 2015. 17 Kyrgyz Republic: Three and a Half Years in the EAEU. January 25, 2019. 18 World Bank Group, PovCalNet. http://iresearch.worldbank.org/PovcalNet/povOnDemand.aspx 19 Ibid.
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beyond basic subsistence, as only 2 percent of the population had reached the middle class (defined as $10 per day) by 2015, nearly unchanged from a decade earlier.20
Figure 2.13. Poverty Gap
Figure 2.14. Poverty Headcount
Low levels of inequality indicate that growth is broad-based and shared across the economy. A common measure of inequality is the Gini coefficient, where lower values imply less inequality. In the Kyrgyz Republic, there was an initial decrease in inequality in the 1990s, followed by a jump in the mid-2000s, then a drop off through 2012 (Figure 2.15). Though it has arrived at a low level relative to its comparators, there has been no consistent reduction in inequality over the past five years. Further, recent declines in inequality have been due not just to increases in consumption by the lowest earners, but also decreased consumption among the top 60 percent of households—the new urban demographic.21 Needless to say, this is not a wholly desirable outcome. Instead, the ideal situation would be increased incomes across income brackets, with faster growth at the bottom of the distribution.
20 World Bank Group, “Kyrgyz Republic: From Vulnerability to Prosperity, A Systematic Country Diagnostic,” 2018, p. 9. 21 Ibid., p. 8.
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Figure 2.15. Gini Coefficient (Inequality)
Income-driven measures of poverty and inequality do not capture all aspects of a society’s well-being. The UN Human Development Index (HDI) was created to provide a broader measure of a society’s level of development by including information not just on per-capita GDP, but also life expectancy and educational outcomes. The Kyrgyz Republic ranks 122nd in the world22 with an HDI score of 0.672 in 2017, a modest improvement from its score of 0.611 in 1991. Georgia ranks highest at 70th in the world, followed by Armenia at 83rd, Moldova at 112th, Tajikistan at 127th, Laos at 139th, and Nepal at 149th.23 The middling ranking for the Kyrgyz Republic implies that it still has some way to go to achieve basic international standards of human development beyond consumption.
Conclusion Since the economic contraction in the early 1990s following its independence in 1991, the Kyrgyz Republic has followed a fluctuating growth path. Its path to a higher level of development has been repeatedly interrupted by continuous political churn, including revolutions in 2005 and 2010. The challenge for the Kyrgyz Republic is to find a path toward inclusive and sustained growth. The rest of this study will examine all facets of the Kyrgyz economy to determine the binding constraints to private sector-led economic growth.
22 The HDI ranks 189 countries on an index normalized from 0 (least developed) to 1 (most developed). 23 United Nations Development Programme, Human Development Reports. http://hdr.undp.org/en/data
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ACCESS TO FINANCE
The financial system plays an important role in allocating capital efficiently within a market-based economy. Without a well-developed system of financial intermediaries to aggregate savings and channel them towards productive investments, the market for credit can suffer from various types of market failures which ultimately make accessing finance for investment purposes difficult or prohibitively expensive.
The level of private investment in an economy is the result of many factors relating to the supply of capital by intermediaries like banks and/or the demand for borrowing by firms and entrepreneurs. A low overall level of investment may be due primarily to a low supply/high cost of investment funds, a low demand for those funds, or some combination of low supply and demand. Supply may be constrained as a result of financial sector problems such as low domestic savings, poor access to international capital, or weak financial intermediation resulting from insufficient competition, high risks, or high cost of bank operations. Such financial sector problems can make interest rates high and investment expensive. Demand for investment funds may be constrained by an unproductive environment for investing due to inadequate supply of a complementary factor like infrastructure and human capital, or due to micro or macroeconomic policy constraints that limit private returns to investment.
This section investigates the Kyrgyz Republic’s financial sector to determine if problems with the sector unduly impact the cost or supply of investment funds and thus seriously constrain investment and growth.
Financial Sector Structure
As summarized in Table 3.1, the Kyrgyz Republic’s financial sector consists of 25 commercial banks (15 local, of which 2 are public, and 10 foreign) and a number of small non-bank financial
Key Messages
• Commercial banks dominate the financial sector, supplying roughly 90% of credit
• The Kyrgyz economy is still relatively cash based. As a share of GDP, bank deposits and bank loans to the private sector are relatively low,
• Interest rates (especially for som-denominated loans) are relatively high. But roughly half of loans are in dollars and interest rates on such loans are 8 – 10 percent lower than for som loans.
• Relatively few firms of any size cite access to finance as the top obstacle to doing business.
• But relatively few firms identify access to finance as the biggest obstacle to doing business
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institutions such as microfinance organizations, credit unions, and exchange offices. There is a stock exchange and a limited number of investment and pension funds, but they are not significant players in either the Kyrgyz financial sector or the economy more broadly. In 2018, the total loan portfolio for banks and non-banks was 134 billion soms, or the equivalent of 26.2 percent of GDP.
Table 3.1. Structure of the Kyrgyz Financial Sector Financial Institutions 2014 2015 2016 2017
Commercial banks 23 24 25 25
Other financial companies, including:
689 656 704 688
Non-banking financial-credit organizations
660 627 673 657
Insurance companies 17 17 19 19
Investment funds 9 9 9 9
Stock exchanges 1 1 1 1
Pension funds 2 2 2 2
Source: National Bank of Kyrgyz Republic Commercial banks account for a large and increasing share24of the total loan portfolio—reaching roughly to 90 percent in 2018. (Figure 3.1) Close to 70 percent of loans go for either trade and commerce, agriculture, or construction, with most agricultural loans provided by microfinance organizations. (Figure 3.2). Moreover, the banking sector is somewhat concentrated. As of 2016, the five largest banks held more than half of all deposits and loans, with the vast majority of loans and deposits occurring in the larger cities (Bishkek, Osh, and Jalal-Abad)25.
24 This increasing share is due in part to the trend of MFIs (e.g. Bai Tuschum, Finca, and Kompanion) obtaining banking licenses starting in 2013. 25 IMF, “Kyrgyz Republic: Selected Issues”, February 2016.
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Figure 3.1. Bank and Non-Bank Loans Figure 3. 2. Bank Loans by Customer Type
For a small country, the Kyrgyz Republic has a relatively large number of bank and non-bank financial institutions. However, most are small and, in fact, the number of bank branches available given the size of the population is low relative to most other comparator countries26. In contrast, ATMs are somewhat more common in Kyrgyz Republic (Figure 3.3).
Figure 3.3. Commercial Bank Branches and ATMs
Source: World Bank, World Development Indicators Similarly, the percent of individuals age 15 and above with a bank account is relatively low but increasing. (Figure 3.4).
26 In general, people in rural areas have limited access to banking services, including payment and transfer services and deposit facilities.
0
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60
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Armenia Georgia Kyrgyz Laos Moldova Nepal
Commercial Bank Branches, 2017 (per 100 thousand adults)
ATMs, 2017 (per 100 thousand adults)
billi
ons o
f KG
Z
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Figure 3.4. Percent Individuals with Bank Account (Age 15+)
Source: World Bank, World Development Indicators Another interesting “player” in the Kyrgyz financial sector is the $500 million Russia – Kyrgyz Development Fund, which was established at the end of 2014 to support the Kyrgyz economy and allow it to take advantage of opportunities arising from membership in the Eurasian Economic Union. To date it has approved more than $300 million of loans—mainly in dollars— to industry, agro-processing, and SMEs at rates well below those offered by commercial banks27.
As is common across Central Asia, the Kyrgyz banking sector exhibits a relatively high rate of dollarization. This could be viewed, at least originally, as a rational response to the macroeconomic instability, depreciation of newly established local currencies, and high inflation that characterized the transition to independence after the collapse of the Soviet Union. Relatively high rates of dollarization have continued to be present despite improved macroeconomic management in the region. In the Kyrgyz Republic, roughly 50 percent of both loans and deposits are made in foreign currencies (primarily dollars)28. While such dollarization does provide borrowers with a greater range of options in terms of risks and costs, and can even enhance a country’s overall macroeconomic stability, it can also make a financial or banking system more vulnerable to liquidity or solvency crises as well as limit the effectiveness of a country’s monetary policy29.
Finally, the overall performance of the Kyrgyz banking sector in terms of mobilizing savings and allocating them towards productive uses appears to be mixed. While gross savings (as a percentage of GDP) are relatively high in Kyrgyz Republic, savings that are mobilized in bank deposits (as a percentage of GDP) are relatively low. The credit provided by banks to the private sector (as a percentage of GDP) is relatively low as well. (Table 3.2) The Kyrgyz economy
27 Loans are made either directly by the Fund or indirectly through participating local banks. 28 Due to perceived currency risks, interest rates for loans in soms are approximately 8-10 percent higher than for foreign currency loans. 29 See Socorro Heysen, “Dollarization: Back to Basics”, Finance and Development, March 2005.
0
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2011 2012 2013 2014 2015 2016 2017
Armenia Georgia Kyrgyz Laos
Moildova Nepal Tajikistan
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continues to be heavily cash based.30 The remainder of this section investigates exactly why this is, and what it says about whether access to finance is a binding constraint to growth for the Kyrgyz economy.
Table 3.2. Savings, deposits, and credit
Gross Savings, 2017
(% GDP) Bank Deposits, 2016
(% GDP)
Domestic Credit to Private Sector, 2017
(% GDP) Armenia 18.1 32.1 51.5 Georgia 23.4 36.6 62.5 Kyrgyz 29.8 19.9 21.8 Laos 18.6 --- --- Moldova 18.7 37.2 27 Nepal 45.6 84.4 79.8 Tajikistan 23.1 12 13.7
Source: World Bank, World Development Indicators and Federal Reserve Bank of St. Louis
Is Finance a Binding Constraint
Is the shadow price of capital high?
In a functioning market economy, if a critical good or service (such as investment capital) is scarce then its price should be relatively high. In the context of the Kyrgyz banking sector, the real cost of capital, at least in terms of local currency, has been consistently high in most recent years, generally above all other comparator countries except for neighboring Tajikistan.31 (Figure 3.5). These relatively high lending rates suggest that affordable access to capital may be a problem for potential borrowers.
30Kyrgyz banking crises that occurred first when the Soviet Union collapsed and then during the 1998 Russian financial crisis may at least partially explain individuals’ apparent reluctance to keep savings in banks. 31 The real interest rate in Kyrgyz Republic dipped significantly in 2011 as a result of a burst of high inflation that followed the “Second Kyrgyz Revolution” in 2010. Interest rates presented in Figure 3.5 for Kyrgyz Republic appear to be for som-denominated loans. As noted previously, interest rates for dollar-denominated loans are significantly lower. For example, in January 2019 average som loan rates were 18 percent versus 10 percent for dollar loans. Between 2013 – 2018 this rate differential between som and dollar loans varied between 4 and 9 percent. Source: National Bank of Kyrgyz Republic.
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Figure 3.5. Real Lending Interest Rate (percent)
Source: World Bank, World Development Indicators A high lending rate may be at least partially the result of a high interest rate spread (i.e. the lending rate minus the deposit rate)32. And in fact, the spread for Kyrgyz Republic has been exceptionally high and consistently well above comparator countries except Tajikistan (Figure 3.6). This is despite the fact that, as described above, the Kyrgyz financial sector is characterized by a relatively large number of modest sized banks and non-banks, both public/private and domestic/local, that are often seen as actively competing for business. A recent IMF analysis indicated that 9.1 percentage points of the 10.2 percent interest rate spread is due to operating costs.33 This is consistent with the IGD team’s conversations on the Kyrgyz banking sector; on several occasions interviewees indicated that the number of bank staff is large relative to the overall portfolio. Operating costs could be brought down by increased adoption of automated loan origination software, for example.
Figure 3.6. Interest Rate Spread (lending rate minus deposit rate, percent)
Source: World Bank, Global Development Indicators Another factor impacting the overall cost or accessibility of capital relates to loan collateral requirements. Higher requirements make it more difficult or expensive for a potential borrower
32This spread is often taken as a proxy for the effectiveness of competition/intermediation within the banking sector, with the idea being that active competition among banks would tend to reduce the spread toward the minimum needed to ensure bank financial viability. 33 International Monetary Fund, Kyrgyz Republic: 2019 Article IV Consultation. July 3, 2019. p. 17.
05
1015202530
2010 2011 2012 2013 2014 2015 2016 2017
Armenia Georgia Kyrgyz Moldova Tajikistan
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1015202530
2010 2011 2012 2013 2014 2015 2016 2017
Armenia Georgia Kyrgyz Moldova Tajikistan
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to acquire a loan. In the case of Kyrgyz Republic, the value of collateral needed to support a loan is about average relative to what is observed in comparator countries (Figure 3.7) and does not vary significantly according to firm size.
In terms of the Doing Business indicator for “Getting Credit”, Kyrgyz Republic ranked 32nd among 190 countries for 2019. This is below (or worse) than Georgia (#12), but exceeds rankings for Armenia (tied #44), Moldova (tied #44), Laos (#73), Nepal (#99) and Tajikistan (#124)34.
Figure 3.7. Value of collateral needed for loan (percent loan amount)
Source: International Finance Corporation, various Enterprise Surveys Overall, the cost of finance does appear to be quite high in Kyrgyz Republic. Interest rates for loans, especially in the local currency, are above those observed for most comparator countries35, while collateral requirements are roughly in line with comparator countries. There are, however, some mitigating factors. For example, dollar loans are available at significantly lower rates, as are, in some cases, loans from the Russian – Kyrgyz Development Fund.36
Do changes in access to finance impact private investment?
Within the context of the HRV methodology, if a binding constraint is relaxed then there should be a positive impact on private investment. In the case of the financial sector, improved access to finance should translate, via lower interest rates (or more available funds), into greater private investment (all else equal).
In Figure 3.8, annual gross fixed capital formation (or investment) as a percent of GDP in the Kyrgyz Republic is plotted against the corresponding real interest rate for the year in question. At least between 2011 (the year after the second Kyrgyz revolution) and 2017 there is a generally positive relation between the levels of investment and the real interest rate. This pattern is
34 This ranking reflects the relative strength of a country’s credit reporting system and the effectiveness of its collateral and bankruptcy laws in facilitating lending. 35 In addition, there is a general lack of longer-term finance, with most loans having maturities of three years or less. 36Dollar loans do come with their own unique risks—especially for businesses working in soms but borrowing in dollars.
0 50 100 150 200 250 300 350 400
Tajikistan (2013)Kyrgyz Republic (2013)
Moldova (2013)Georgia (2013)
Armenia (2013)Laos PDR (2016)
Nepal (2013)
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consistent with the view that shifts in the demand for investment are the main determinant of changes in the level of investment; and in general, it does not support the position that changes in the supply of credit (and hence the cost of finance) are driving changes in investment in Kyrgyz Republic—at least in recent years.
Figure 3.8. Investment and Interest Rates in Kyrgyz Republic
Are economic agents trying to bypass any constraints on access to finance?
In this context, it is useful to start by considering whether or not firms see access to credit as an obstacle to doing business. According to the World Bank’s 2013 Enterprise Survey, less that 5 percent of firms in the Kyrgyz Republic identified access to finance as the top business obstacle that they faced.37 This response was lower than for firms in comparator countries. While small firms in the Kyrgyz Republic were much more likely to report access to finance as their top business constraint than medium or large firms—7 percent of small firms vs. roughly 4 percent and 1 percent of medium and large firms respectively—these rates are still low relative to most comparators (Figure 3.9).
37 The most recent Enterprise Survey for Kyrgyz Republic was published in 2013, with most firm data collected from a stratified sample of 200 firms across the country in 2012, or two years after the 2010 Revolution. This timing may at least partially explain why political instability was the most frequently cited (36 percent of all firms) top business obstacle for all sized firms—followed by competition from the informal sector (20 percent), corruption (12 percent), tax rates (9 percent ), and an inadequately educated workforce (6 percent). In a survey of firms in Kyrgyz Republic done for the World Economic Forum’s 2017-18 Global Competitiveness Index, corruption was judged to be the most problematic factor for doing business (with a weight of 22.4) followed by policy instability (11.2), Government instability (10.2), access to finance (8), taxation (6.9), inflation (5.9), inadequate infrastructure (5.7), and an inadequately educated workforce (5.3).
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Figure 3.9. Firms Identifying Access to Finance as an Obstacle (percent)
Source: International Finance Corporation, various Enterprise Surveys The Enterprise Survey also asks firms about “major”38 constraints to business; and the results paint a somewhat different picture, with about 26 percent of firms in Kyrgyz Republic describing access to finance as a major, as opposed to top, constraint. This 26 percent figure for Kyrgyz firms is similar to what is observed in other comparator countries, as well as for other types of major constraints cited by Kyrgyz firms.39 (Also Figure 3.9)
Perhaps more telling than what firms say about access to finance is what their behavior reveals. For instance, the ability of firms in the Kyrgyz Republic to actually access lines of credit or loans appears to be similar or better than what is observed in comparator countries. (Figure 3.10).
Figure 3.10. Firms with Line of Credit or Loans from Financial Institutions (percent)
Source: International Finance Corporation, various Enterprise Surveys
38 A major constraint is defined to be a “major” or “very severe” obstacle to a business. 39 Roughly 60 percent, 35 percent, 34 percent, 29 percent, and 28 percent of Kyrgyz firms identified corruption, unreliable electricity supply, inadequately educated workforce, high tax rates, and competition from the informal sector respectively as major constraints.
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Armenia (2013) Georgia (2013) Kyrgyz (2013) Laos (2016) Moldova (2013) Nepal (2013) Tajikistan (2013)
Small Firms Identifying Access to Finance as Biggest Obstacle (5-19 employees)Medium Firms Identifying Access to Finance as Biggest Obstacle (20-99 employees)Large Firms Identifying Access to Finance as Biggest Obstacle (100+ employees)
0 5 10 15 20 25 30 35 40 45 50
Armenia (2013)
Georgia (2013)
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Laos (2016)
Moldova (2013)
Nepal (2013)
Tajikistan (2013)
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Further evidence from the Enterprise Survey (Figure 3.11) suggests that firms in the Kyrgyz Republic rely rather heavily on internal funds to finance investment. This could be due to some combination of factors relating to: the availability and/or cost of capital, the effectiveness of financial intermediation, and firm preferences relating to investment finance.
Figure 3.11. Enterprise Financing Sources for Investment
Source: International Finance Corporation, various Enterprise Surveys Overall, the evidence presented above does not clearly and unequivocally support the view that from the firm perspective access to finance is a binding constraint in the Kyrgyz Republic. In contrast to what is observed in many countries, relatively few firms cite access to finance as the top obstacle they face. While it is the case that firms do rely rather heavily on internal financing for investment, this may reflect, at least to some extent, the generally cash-based nature of the economy and wide spread wariness of banks
Conclusion The evidence concerning whether or not access to finance is a binding constraint in the Kyrgyz Republic is mixed, somewhat contradictory, and at times hindered by data limitations. It is clear that the level of credit provided by the banking system to the private sector is relatively low. The credit market is thin with a limited number of products. And the cost of credit—at least for som denominated loans—is relatively high (as well as available only in a limited range of short to medium term maturities). However, interest rates for dollar denominated loans, which account for 40 – 50 percent of banks’ loan portfolios, are considerably lower. The Russia – Kyrgyz
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Development Fund also offers another substantial source of relatively low-cost credit40. Collateral rates are not particularly high relative to comparator countries.
Limited macroeconomic evidence does not support the view that that changes in the supply of credit (and interest rates) are the primary determinants of changes in investment levels. At least as of 2013, businesses relied heavily on internal sources of finance for investment. Somewhat paradoxically, the percent of firms identifying access to finance as a top or significant business obstacle was generally not high relative to most comparator countries.
In summary, it appears to be the case that some potential borrowers—likely small to medium sized and in more rural locations—may find it difficult and/or expensive to access finance. But overall, relatively few firms of any size “complain” about problems with access to finance. Preferences for self-financing investments do seem to be prevalent—perhaps reflecting prior banking crises and the largely cash-based nature of the economy. And for larger and more economically significant borrowers in major urban area lower cost credit options are fairly widely available. Thus, the evidence at present does not make a clear unequivocal case for access to capital being a binding constraint to private investment and economic growth in the Kyrgyz Republic.
40 The Russia-Kyrgyz Fund has supported loans of more than $300 million to date, which is equivalent to roughly 17 percent of the banking system’s total loan portfolio.
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4 MICROECONOMIC RISKS
4.1 Introduction
The evidence reviewed in this chapter supports the conclusion that microeconomic risks and distortions are a binding constraint to private sector growth and investment. Specifically, this chapter provides evidence that the binding constraint to economic growth is weak economic governance that increases the costs and risks of doing business and investing. While the Kyrgyz Republic has made progress regarding democratic governance and investment-friendly policy reform, especially in relation to other countries in the region, the government has been unable to establish effective institutions that fairly and judiciously apply the law and enforce existing policies and regulations. Because enforcement of the law is coupled with political influence, and political power in the Kyrgyz Republic changes frequently, the implementation of the law becomes subservient to political power, rather than politics being subservient to the law.
Weak economic governance is the most binding constraint to economic growth and investment because it significantly increases the cost and risk of doing business in the Kyrgyz Republic and is a major deterrent to long-term planning and foreign investment. Existing businesses cannot rely on consistent and transparent application of the policies that govern the business enabling environment, such as tax policy, labor laws, and contract enforcement. The binding constraint is also a major deterrent to new investment, which results in substantial underdevelopment of the country’s vast and potentially profitable natural resources, particularly in mining and hydropower—industries that would likely require the financial resources and technical expertise of foreign companies. Kyrgyzstan will continue to underperform its potential GDP until it becomes an attractive destination for foreign investment.
Microeconomic constraints fall under the second branch of the inclusive growth diagnostic tree – low returns to investment. The micro section focuses on Kyrgyz Republic’s approach to the establishment and implementation of specific rules, regulations and policies that can either promote broad-based economic growth or impede its progress.
Key Messages
• The binding constraint to private sector economic growth is the inconsistent and unreliable application of the law.
• Evidence from all four HRV tests shows that poor and unpredictable implementation of the law harms the country’s economic growth.
• In many cases, economic governance is relatively strong on paper, but private sector firms struggle to operate and grow in a business climate subject to frequent political and economic changes.
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4.2 Global Performance on Microeconomic Indexes & IndicatorsOn a global scale, the Kyrgyz Republic ranks near the middle of all countries on measure of business competitiveness. The country ranks 70th overall in the World Bank’s Doing Business Report, which measures the de jure obstacles to private investment and entrepreneurship in 190 countries (Figure 4.1).41 The country’s ranking falls within the middle of the comparator countries with particularly high scores in the following dimensions: registering property, dealing with construction permits, getting credit,42 starting a business and protecting minority investors. There are, however, three Doing Business categories where the Kyrgyz Republic has relatively poor scores: getting electricity, paying taxes, and enforcing contracts.
Figure 4.1 Doing Business Rankings, 2019 (lower values are better)
Source: The World Bank Doing Business Report, 2019. The Doing Business indicators show an interesting trend in the business regulation lifecycle. Kyrgyz regulations are very business friendly in the early stages of firm startup: the country ranks very highly in starting a business, dealing with construction permits, registering property, and getting credit, all of which are basic needs of a new business (electricity is the notable exception, a topic addressed in detail in the infrastructure chapter). However, once a company is
41 Doing Business measures the rules of the business environment and identifies areas for regulatory improvement by scoring and ranking economies across 11 dimensions and 190 countries. 42 The good Getting Credit score in the Doing Business Report should not be interpreted as contradicting the conclusions in the finance chapter. DB only measures legal rights and credit information and not the price or availability of financing.
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World Rank (out of 190)
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established and begins operations, its relationship with the government dramatically changes. The Kyrgyz Republic ranks very poorly in the operational regulations related to paying taxes, enforcing contracts, and resolving insolvency. As such, regulation is most constraining for existing and growing firms, not new firms.
Another international data source that makes cross-country comparisons of the business environment is the World Economic Forum (WEF) Global Competitiveness Index (GCI), a collection of economic indicators from publicly available international indicators and annual Executive Opinion Surveys. In 2017-18, the Kyrgyz Republic had an overall GCI rank of 102 out of 137 countries, placing it behind all comparator countries (Figure 4.2). The country’s relatively poor overall ranking driven by low competitiveness rankings associated with the following: institutions (103), infrastructure (109), labor market efficiency (113), market size (117), business sophistication (127), and innovation (126).
The country’s institutions ranking (103) is driven by low scores for property rights, security, and low accountability. The country’s infrastructure ranking (109) is influenced by poor transport infrastructure. Low scores for labor market flexibility (e.g. labor-employee relations; wage determination) and efficient use of talent (e.g. capacity to attract or retain talent) impacted the country’s labor market efficiency ranking (113). The Kyrgyz Republic’s ranking for market size (117) is driven by small domestic and foreign markets, while the business sophistication (127) and innovation (126) rankings are influenced by poor distribution channels, value chain development, and research and development, among other factors.
Figure 4.2. The Global Competitiveness Index, 2017 (country rank out of 137)
Source: World Economic Forum, Global Competitiveness Index dataset, 2007-2017.
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In the 2017-18 WEF Executive Opinion Survey, executives were asked to identify the most problematic factors impacting businesses. In the Kyrgyz Republic, 22.4 percent of respondents identified corruption as the most problematic factor, followed by political instability (11.2 percent), government instability/coups (10.2 percent), and access to finance (8.0 percent). The portion of firms identifying corruption as the most problematic factor was higher than any other comparator, and political instability and government instability/coups ranked second highest. The portion of the country’s firms identifying access to finance as a constraint was lowest among comparators.
A third international source, the Fraser Institute Economic Freedom Index (EFI), is comprised of data from third party sources like the International Country Risk Guide, the GCI, and the World Bank’s Doing Business indicators. In the EFI, each country receives a score between 0 and 10 that is based on 42 variables within five major topic areas. In 2016, the Kyrgyz Republic had an overall score of 6.93, which is third best among the comparator countries behind the two most developed among them, Armenia and Georgia (Table 4.1).
Although it has a relatively high EFI score, it is important to note that the Kyrgyz Republic scores particularly poorly in the two sub-components that are most relevant to the binding constraint: legal system & property rights (4.26) and regulation (6.63). The low score for legal systems and property rights is driven by sub-scores related to judicial independence, impartial courts, property rights, military interference in rule of law and politics, legal enforcement of contracts, and reliability of police. The country’s relatively low regulation score is influenced by poor credit market and business regulations.
Table 4.1. Economic Freedom Index, 2016
Countries Overall Size of
Government
Legal System & Property
Rights
Sound Money
Freedom to trade inter-
nationally
Regulation
Georgia 8.02 7.53 6.31 9.22 8.56 8.49 Armenia 7.57 7.00 5.81 9.52 8.14 7.35 Kyrgyz Rep. 6.93 7.08 4.26 9.36 7.32 6.63 Laos 6.90 7.84 5.94 7.34 6.83 6.55 Tajikistan 6.72 6.53 5.12 8.83 6.36 6.74 Moldova 6.63 6.50 4.34 7.98 7.46 6.87 Nepal 6.53 7.92 4.61 6.44 6.64 7.04
Source: The Fraser Institute, Economic Freedom Index, 2016. The final international source, the World Bank’s Enterprise Survey, is a firm-level survey focusing on constraints to the private sector. Unlike previously mentioned surveys, this survey is not reported on a regular basis, and the most recent survey in the Kyrgyz Republic is from
49
2013.43 The timing of the Enterprise Survey may influence responses so this should be considered when assessing survey results.
In the 2013 Enterprise Survey, firms were asked to select the biggest obstacle to the success of their businesses (Figure 4.3). Out of 15 different options, 36.1 percent of firms selected political instability as their biggest obstacle, followed by practices of the informal sector (19.9 percent), corruption (11.9 percent), and tax rates (9.7 percent). The portion of firms identifying political instability, practices of the informal sector, and corruption combined was second highest relative to the comparators.
Figure 4.3. Enterprise Survey: Biggest Constraint (percent of firms)
Source: Enterprise Survey (2013)
Much of the Kyrgyz economy is informal, and the Enterprise Survey shows that informality is a larger constraint to private sector business than the comparator countries. Although competition with informal firms is a problem, with 20 percent of firms identifying it as their biggest constraint (Figure 4.5), the existence of a large informal sector is a symptom rather than a cause. Research by La Porta and Schleifer (2014) shows that firms choose to be informal unless the incentives to formalize, namely access to finance and legal protections, are large enough. Informality allows firms to avoid tax payments, underreport revenue, avoid business and labor regulations, and avoid audits, among other benefits. Since self-selection into the informal sector is high, the development of effective enforcement institutions will be necessary to encourage firm registration and increase compliance with tax and labor laws.
43 The next iteration of the Kyrgyz Republic Enterprise Survey is scheduled for release in the fall of 2019.
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Figure 4.4. Percent of Firms Competing Against Informal Firms
Figure 4.5. Percent of Firms Identifying Informality as Their Biggest Obstacle
Source: Enterprise Surveys To conclude, the Kyrgyz Republic’s overall performance in international rankings, indexes, and indicators provides an indication of the potential binding constraints to private investment and entrepreneurship. A broad overview of all the international indicators points towards a binding constraint related to regulation, the rule of law, and political instability. These and other microeconomic variables are the focus of the remainder of this chapter.
4.3 Microeconomic Issues in the Kyrgyz Republic
Regulatory Quality
In an ideal economy, governments establish and maintain a set of rules and regulations to promote the free exchange of goods and services, and government institutions are effective enough to enforce those rules and regulations. Under these conditions, market distortions like rent seeking and monopolies are eliminated or reduced. In contrast, excessive regulation and ineffective institutions hinder domestic and international investment through unnecessary bureaucratic processes, risks, and costs. To bypass an inefficient regulatory regime, firms may choose to invest in other countries or operate in the informal economy. Excessive regulation may also cause firms to be incapable or unwilling to expand their businesses.
According to the World Bank’s World Governance Indicators (WGI), regulatory quality “captures perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development.” In 2017, the Kyrgyz Republic had a percentile rank of 38.46 in terms of WGI Regulatory Quality indicator, meaning the country scored higher than 38 percent of the 215 countries (Figure 4.6). The country’s percentile rank represents the median value compared to the comparator countries.
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The EFI regulation score is comprised of three variables, including credit market, labor market, and business regulations. From 2012 to 2016, the Kyrgyz Republic had a regulatory score of 6.63 out of 10. This figure represents the second lowest score among comparators. With regards to the regulatory components, the Kyrgyz Republic had the lowest score for credit market regulations; the third highest score for labor market regulation; and the second lowest score for business regulations. There are two factors driving the low credit market regulations score: a low level of private banking ownership and interest rate controls. The low business regulations score is reflective of excessive administrative requirements, high bureaucratic costs, and informal payments or favoritism.
Figure 4.6. Regulatory Quality
Source: World Bank WGI; World Bank Doing Business Report If regulations are a binding constraint to growth, then measures of regulatory quality would be lower than the comparators and low for the Kyrgyz Republic’s level of economic development. As shown in Figure 4.7, there is a moderate correlation between regulatory quality and GDP. With a few outliers, high income countries have much higher regulatory quality than low income countries. The Kyrgyz Republic regulatory quality is slightly above the expected value (for its income level), which suggests that poor (de jure) regulatory quality is not unusual for a country at the level of development of the Kyrgyz Republic.
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Figure 4.7. Regulatory Quality and GDP
Source: World Bank WGI and WDI
If regulations are a binding constraint, firms should be attempting to circumvent those regulations. Firms can avoid regulatory costs by remaining in the informal economy or by capping their formal growth. According to the IMF and ADB, the size of the informal economy is influenced by the quality of institutions, corruption, and weak rule of law. Although the World Bank identifies high compliance costs are one of the causes of informality, these costs are mainly associated with the de facto implementation of regulations and not the de jure design. In addition, the World Bank states that in Kyrgyz Republic there are low rates of graduation to medium or large firms, which could be attributed to firms avoiding governance risks or higher compliance costs (2018).
To determine if individuals and firms in the Kyrgyz Republic experience regulatory barriers that are significantly higher than comparators, the analysis considers the costs, time burden, and number of procedures that a firm needs to comply with when dealing with government regulations, obtaining permits, and an electricity connection. According to the 2019 Doing Business Report, the Kyrgyz Republic has relatively low regulatory costs (Figure 4.8). For instance, the Kyrgyz Republic had the third lowest costs for starting a business and registering property.
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Figure 4.8. Regulatory Costs
Source: Doing Business
In the 2019 Doing Business Report, the Kyrgyz Republic did not report a relatively high number of procedures, nor was the time burden for obtaining public services significantly different from the benchmark countries (Figure 4.8). However, there are mixed results regarding the time required to deal with regulatory requirements and to obtain a business license or permit. When firms are surveyed in the Enterprise Survey, senior managers in the Kyrgyz Republic say they spend an average of 12 percent of their time dealing with regulatory requirements, which places the country below only Tajikistan (21.9 percent) and Armenia (12.2 percent). The Kyrgyz Republic reported the longest amount of time to obtain an operating license (30.8 days), a construction license (73.3 days), and an electrical connection (54.6 days).44
The Gap between De Jure Design and De Facto Implementation
The discrepancy between the time burden reported in the Doing Business report, which measures de jure laws and regulations and the actual time to comply with those laws and regulations, and the Enterprise Survey, which only measures firm perceptions and experience, is one of the most telling indicators that the binding economic constraint lies within the application—rather than the design—of the law.45 An effective business enabling environment requires both a good regulatory framework and public confidence in that framework. In the Kyrgyz Republic, the problem is the latter.
44 In the Kyrgyz Republic, medium-sized firms reported a greatest number of days to receive a construction permit (93.5) or an electrical connection (80.8), while large firms reported the longest time to obtain an operating license (42.6). 45 Doing Business does measure actual practices in addition to legal indicators and is not a purely de jure legal measure. Time indicators, such as the number of days to complete a regulatory requirement, are based on actual practice but assume that all procedures are followed in sequence and that the fastest procedure is taken. Thus the number and types of steps required in a regulatory process are captured in Doing Business, whereas the ES does not break down a regulatory process into steps; ES simply asks how long a certain process took.
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One example of the gap between design and implementation of the laws and regulation is the number of days required to obtain a construction permit. According to the Doing Business report, which measures time in accordance with all regulatory requirements, a construction permit is expected to take 142 days. While the Kyrgyz Republic has much room for improvement, it ranks near the middle of the comparators and does not suggest an unusually high cost or burden to private sector business. However, when a similar question is asked in the Enterprise Survey, the Kyrgyz Republic is a clear outlier with permits taking more than twice the average time as permits in the second ranking country, Tajikistan (Figures 4.9 and 4.10).
Figure 4.9. Days to Obtain a Construction Figure 4.10. Days to Obtain a Permit – Doing Business Construction Permit – Enterprise Survey
Source: Doing Business and Enterprise Survey Other measures of regulatory performance tell a similar story. Both Doing Business and the Enterprise Survey measure the number of days to get an electricity connection and the number of days to obtain an operating license to start a business. In both cases, Doing Business time is near the middle of the comparators, but ES is by far the longest: electricity connection time is nearly 2.5 times longer than the second comparator, Nepal. (Figures 4.11- 4.14)
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Figure 4.11. Days to get an Electricity Figure 4.12. Days to get an Electricity Connection – Doing Business Connection – Enterprise Survey
Figure 4. 13. Days to Obtain an Operating License – Doing Business
Figure 4.14. Days to Obtain an Operating License – Enterprise Survey
Source: Doing Business and Enterprise Surveys, World Bank Group In conclusion, the difference between the Doing Business and Enterprise Survey results suggest that there is a gap between how long business procedures take based on compliance with formal regulations and the time it actually takes to complete the procedures based on firm perceptions. While the methodologies differ, the pattern we see in relation with the comparator countries is that the Kyrgyz Republic performs much more poorly in the Enterprise Survey than in Doing Business. This trend suggests that firms’ experience with business regulation is much more burdensome than what appears in a more formal review of legally established procedures.
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Political Stability and Rule of Law
This section assesses the state’s ability to attract investments by maintaining a stable, effective, and accountable government. The analysis focusses on two areas of governance – political stability and rule of law.46 Political instability raises the cost of investment and increases the riskiness of investments. Low confidence in the rule of law, including low expectations for the implementation of official rules or regulations, creates unfavorable investment environments where legal protections are not guaranteed.
Indeed, instability is one of the key drivers of mistrust between government officials and the private sector, and many firms cannot trust government officials to properly enforce the law. Despite reform efforts to improve the business enabling environment, the ADB (2013) writes, that “One problem is that these reforms are either being poorly implemented or rendered ineffective by legal ambiguities. Unlawful interference in business by government officials is widespread—and strongly linked to the reported practice of job buying and the use of personal connections for getting jobs in the government. There is considerable mistrust of the government in the business community, with investors wary of making substantial, long-term commitments.” UNCTAD (2016) describes the economic situation in similar terms: “The Government is deemed to have failed to effectively protect property from expropriations or illegal seizing by private groups during times of social upheaval or after government changes. Also, in the mining sector, the revocation of a number of licenses and recent changes in the taxation regime after the 2010 revolution raised concerns about the profitability of investments […]. Even though it is unclear whether expropriations and license revocations were targeted in particular at foreign investors, the general situation is perceived as a deterrent to new investments.”
Survey data backs up these claims, and Kyrgyz firms have consistently identified political instability as a major constraint to business. In the 2017-18 WEF Executive Opinion Survey and the Enterprise Survey, the portion of respondents identifying political instability as a major constraint was second only to Nepal. However, the nature of this concern has reportedly shifted over time, from security related concerns after the 2005 and 2010 revolutions to public dissatisfaction with the government’s ability to create a sustainable political environment (World Bank 2018). According to the WGI, the Kyrgyz Republic’s percentile rank is in the bottom third for political instability and voice and accountability. However, the country’s ranking has improved in recent years, and it now ranks within the middle of the benchmark countries for political instability and accountability. (Figure 4.15)
46 “Rule of law” is broadly defined and covers issues such as contract enforcement, property rights, control of corruption, and courts.
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Figure 4.15. World Governance Indicators (percentile rank; higher is better)
Source: World Bank WGI Political instability does correlate with economic performance, which is evidence of the second HRV test for sensitivity. Figure 4.16 below shows the GDP growth rate and the WGI political instability scores between 2002 and 2016 (using a three-year moving average to smooth out changes over time). Growth correlated strongly between 2002 and 2010, after which the economy grew rapidly in the years following the 2010 revolution. The correlation is less strong after 2010, although the increasing levels of political stability bode well for economic growth to stabilize at the long-run average of about 4.5 percent per year and to avoid the type of growth collapse that has occurred during previous periods of political upheaval.
Figure 4.16. Political Instability of GDP Growth Rate (3-year moving average)
Source: WGI and WDI
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Political instability and the resulting legal uncertainty are one of the most common complaints among business people. As one interviewee explained, the political uncertainty in the country changes the selectivity of legal enforcement, i.e. which laws are enforced and how. Another interviewee complained that unpredictability makes long-term investment difficult, particularly in industries that require high upfront capital investment and 5-20 years of forward thinking in order to justify investment. A 2014-member survey from the International Business Council in the Kyrgyz Republic backs up these anecdotes: “predictability of laws and regulations” was identified as the most important issue when planning investments in the country.47
The World Bank’s WGI Rule of Law indicator “reflects perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement; property rights, the police, and the courts, as well as the likelihood of crime and violence.” In 2010, the Kyrgyz Republic had one of the world’s lowest rule of law scores with a percentile rank of 8.5. By 2017, the country’s ranking had improved to 17.3 percent although it still had the second lowest ranking compared to the benchmark countries (Figure 4.15).
The rule of law is also reflected in the courts’ ability to enforce regulations. Among comparators in the 2016 Economic Freedom Index, the Kyrgyz Republic has the second lowest score for judicial independence (3 out of 10) and impartial courts (3.1 out of 10). Similarly, in the 2017-2018 GCI the Kyrgyz Republic has the second lowest country ranking for judicial independence (102 out of 137) and efficiency of legal framework in settling disputes (96).
The financial cost of contract enforcement in the Kyrgyz Republic is significantly higher than other comparator countries. In 2019, for example, the cost of contract enforcement is 47 percent of the claim, almost 16 percentage points higher than the closest comparator (Figure 4.17). Although the cost is substantially higher, the country had the second shortest average time (410 days) for contract enforcement. Nevertheless, for a business without enough capital to engage the legal system, the cost of enforcing a contract is potentially prohibitive.
47 Aktilek Tungatarov, Nurbek Maksutov, and Asel Bogombaeva, Predictability of Legislation is a major priority for investors in Kyrgyz Republic, http://www.ibc.kg//uploads/publications/1419931700.pdf
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Figure 4.17. Cost of Enforcing Contracts Figure 4. 18 Cost of Crime
Source: World Bank Doing Business Report and Enterprise Survey. There is some evidence that firms are attempting to circumvent the costs or time burdens associated with governance issues. According to the ADB, IMF, and World Bank, there are many informal micro and small firms because of the perceived risks associated with poor governance, high compliance costs and weak rule of law. Moreover, the low rates of graduation of small formal firms to medium or large firms is due in large part to businesses avoiding the perceived governance risk and compliance costs associated with growth.
Another product of instability and poor rule of law is crime. Among the benchmark countries in the 2016 Economic Freedom Index, the Kyrgyz Republic had the lowest score (3.6 out of 10) for the reliability of police and the second lowest score (5.3) for business costs of crime. Similarly, in the 2017-2018 GCI the country had the lowest country ranking for organized crime (102) and the second lowest country ranking for the business costs of terrorism (103), the business costs of crime and violence (84) and the reliability of police services (107).
In the Enterprise Survey, the Kyrgyz Republic had the highest percentage of firms identifying crime, theft, and disorder as a major constraint (18.3 percent), followed by Nepal (13.8 percent), Tajikistan (8.3 percent) and Moldova (5.6 percent). The country also had the highest reported level of crime with 13.6 percent of firms experiencing losses due to theft and vandalism. (Figure 4. 18) While the reported frequency of crime was higher, the average loss per crime is lower. For example, the average loss to firms was 3.3 percent of sales, compared to 10.2 percent in Nepal, 3.6 percent in Armenia, 3.1 percent in Moldova and 1.9 percent in Laos.48
It is important to note that although the crime statistics from the Enterprise Survey do stand out among the comparators, the numbers are not consistent with observations on the ground or with
48 Georgia and Tajikistan have no reported results for this Enterprise Survey Indicator.
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the many stakeholder interviews conducted as part of this report. In fact, crime was not mentioned a single time in the several dozen stakeholder interviews the IGD team held over two weeks, nor is it mentioned at all in detailed reports such as the World Bank’s 2018 Systematic Country Diagnostic. For these reasons, we do not believe crime to be a constraining factor overall. The new version of the Enterprise Survey, to be released in the fall of 2019, may shed light on whether crime is still perceived to be an issue. That being said, there have been cases of crime deterring foreign investment in the mining sector. In a well-documented incident in 2011, international investors in the Talas gold mine pulled out of the country after a raid on the mining camp and death threats were sent to government officials.
To conclude, this section provides substantial evidence that political instability and rule of law are major constraints to private sector business. Together, these issues combine to create a volatile business environment in which political instability affects how the economic laws and regulations are applied. We find evidence that political instability is high, the quality of the rule of low is low, economic growth correlates with political instability, and circumvention is high.
Corruption
Corruption deters domestic and foreign investment by adding unnecessary and oftentimes hidden costs to the production of goods and services. Corruption also increases the uncertainty of doing business, thereby reducing the willingness of businesses to invest and deal with a country’s bureaucratic processes. The analysis will determine whether corruption is a binding constraint to private sector investment, although we conclude that corruption is a symptomatic of governance constraints and not itself a binding constraint.
The World Bank’s WGI evaluates a country’s performance in the control of corruption. According to the World Bank, the indicator “captures perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as "capture" of the state by elites and private interests.”49 In 2017, the Kyrgyz Republic had a percentile rank of 13 for corruption, indicating the country scored in the bottom 13 percent of all 215 countries assessed in the WGI data set (Figure 4.19). This ranking compares to a percentile rank of 16.7 and 4.8 in 2002 and 2009, respectively.
Transparency International’s annual Corruption Perceptions Index (CPI) seeks to measure the level of public sector corruption in 180 countries by providing a corruption score ranging from 0 (highly corrupt) to 100 (very clean). In 2017, the Kyrgyz Republic received a score of 29 and ranked 135 out of 180 internationally. The Kyrgyz Republic’s CPI rank is tied for 6th out of benchmark countries, with the country positioned below Tajikistan (161st) and tied with Laos (135th). (Figure 4.20)
49 See Global Governance Corruption indicator at http://info.worldbank.org/governance/WGI/#doc.
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Figure 4.19. Control of Corruption Rank Index (out of 180)
Figure 4.20. Corruption Perceptions Index (out of 180)
Source: The World Bank; Transparency International If corruption is a binding constraint, then individuals and firms should observe an informal cost of receiving public services that is significant relative to the formal price. According to the World Bank’s Graft Index, a measurement of the number of times a person submits an informal payment in exchange for a public service, someone in the Kyrgyz Republic is expected to pay a bribe in 16 percent of their interactions with public officials. In instances where there was a bribe reported, the amount the household spends represents anywhere from 5.6 to 6.3 percent of household consumption.50
According to the Enterprise Survey, the prevalence of informal payments is high. In 2013, 59.8 percent of firms reported at least one informal payment request (bribery incidence) and 53.6 percent claimed that a public transaction required an informal payment (bribery depth; Figure 4.21). Both figures were significantly higher than for any of the other comparator countries. Additionally, the value of informal payments pertaining to public procurement are high. In 2013, for example, firms were expected to pay 2.2 percent of the contract value to secure a government contract. Only Nepali firms reported a higher payment (4.4 percent).
50 Across all households, the bribes represent between 1.0% and 1.5% of household consumption.
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Table 4.21. Bribery Incidence and Depth
Source: Enterprise Survey, World Bank, 2013 and 2016. Corruption is a difficult issue to parse because it can be seen as a constraint by itself or as a symptom of a broader constraint. f corruption is a binding constraint, firms should be attempting to circumvent the cost of corruption. There are several qualitative sources claiming corruption is a strong driver of informality, although it is not clear the being informal obviates the need for a firm to pay bribes or engage in other corrupt practices with authorities. In 2006, entrepreneurs identified corruption as the primary factor firms stay in the informal economy (UNDP, 2006). More recently, the World Bank asserts informality is a response by firms to poor governance, including the expectation of informal payments (2018). Similarly, the ADB claims one of the major reasons a business choses informality is “to avoid being subject to rent-seeking or even expropriation” (2013).
There is no doubt that corruption is high and remains a major problem in the Kyrgyz Republic; 60 percent of firms identify corruption as a major constraint. However, we find it difficult to isolate corruption from other microeconomic constraints, and we view corruption as symptomatic of the economic and political governance failures that constitute the true binding constraint to growth. It is impossible to address the corruption issue without first addressing the root cause of the governance failures.
Taxes
Tax rates and tax administration are two topics of particular importance to private sector growth. It is the job of the government to strike a balance with a tax system that generates the revenue necessary for pro-growth investments in human capital, infrastructure, security, and other areas of public interest, while also fostering a competitive business environment. While there is no single tax rate that is appropriate for all countries, it is always important that the tax system be transparent, fair, and predictable while imposing a low administrative burden on firms that are looking to comply with the law.
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Bribery Incidence Bribery Depth
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If tax rates and administration are a binding constraint, then firms should observe a cost of submitting taxes that is greater than comparator countries. In the 2019 Doing Business Ease of Paying Taxes, the Kyrgyz Republic places fifth among comparators and 150 out of 190 economies. The country’s firms are expending 29 percent of profit towards taxes, with an average of 51 payments per year and 225 hours spent filing, preparing, and paying taxes (Figure 4.22). The number of hours spent on taxes is close to the international median, but the Kyrgyz Republic has one of the highest number of payments of any country. Meanwhile, the overall ease of paying taxes score from the Doing Business report ranks the third lowest among comparators at just 57 out of max score of 100, and the score has actually declined some in recent years from its peak of 65 in 2011 (Figure 4.23).
Figure 4.22. Tax Burden (hours to pay taxes and number of tax payments)
Figure 4.23: Ease of Paying Taxes Score
Source: WDI Source: World Bank Doing Business Report, 2019.
Looking at firm perceptions of taxes, the Enterprise Survey suggests that taxes are considered a hindrance but not a binding constraint. Although 28.9 percent of respondents identify tax rates and 21.1 percent identify tax administration as major constraints, only 9.7 and 0.percent of firms identify tax rates and tax administration as the biggest obstacle, respectively. The number of respondents selecting taxes as the biggest obstacle was lower than most comparators. Similar findings were produced in the Fraser Institute EFI and WEF Executive Opinion Survey. In the WEF Executive Opinion Survey, for example, firms cite tax regulations as the fifth most problematic factor and tax rates as the eighth most problematic factor. The International Finance Corporation (IFC) has also measured the Kyrgyz Republic’s progress in regard to various tax rates and procedures. Between 2012 and 2016, the Kyrgyz Republic made major progress in reducing tax costs and tax burden. The time burden to administrate taxes
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dropped by almost 17 days, from an average of 40.4 person-days in 2012, to 23.6 person-days in 2016 (Figures 4.24 and 4.25). Figure 4.24. Tax Costs by Year 4.25. Tax Time Burden by Year
Source: International Finance Corporation, World Bank, 2016. If taxes are a constraint, the most successful firms are those firms with a lower tax burden, while firms unable to bear this burden will choose to operate in the informal economy. The characteristics of a firm, such as its size and profits, have a direct impact on the level of taxes it pays and the tax regime it falls under. For instance, a firm with profits between 1 and 4 million KGS pay an average of $350 per year in tax administration costs, compared to $661 for a firm with 8 to 30 million KGS in profits. Small firms, however, pay a greater portion of their profits towards taxes. Firms making annual profits of less than 1 million KGS pay 2.2 percent of their profits towards taxes, compared to 0.04 percent of profits for large firms (IFC 2017). However, the IMF posits that the size of the informal economy is influenced predominately by the quality of its institutions (IMF, 2016). Similarly, the World Bank and ADB claim that the contributing factors to informality are corruption, weak rule of law, and increasing compliance costs, so it does not appear that taxes are a key driver of informality.
Another important consideration for the tax system in the Kyrgyz Republic is the unique use of the “patent” licensing system. The patent is a system by which entrepreneurs can apply for a business license that streamlines tax payment and regulatory burden through the use of an upfront registration fee. An entrepreneur applies for a patent, pays the required fee, and becomes formally registered. Although this system is legal, many economic experts in the country believe that the patent system is frequently abused, reduces tax revenue, and undermines the productivity of firms. For example, firms that hire multiple workers can bypass regulatory requirements by having their employees apply for entrepreneurship patents. By doing so, the firm becomes a collection of “individual entrepreneurs” rather than a firm with a traditional management and payroll structure. Although the patent system was well intentioned at the time of its creation as a
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means to incentivize formality, the system is now frequently used to hide revenue, reduce tax payments, avoid labor regulations, and misrepresent the true size of the firm.
In sum, taxes do not appear to be a constraining factor relative to other microeconomic risks. There is much work to be done to improve the efficiency of the tax system and reform the outdated patent system, but overall tax rates and tax burdens are not unusually high relative to the comparator countries.
Customs and Trade Regulation
The Kyrgyz Republic has been a member of the World Trade Organization (WTO) since 1998 and in 2015 it acceded to the Eurasian Economic Union (EAEU). The economic benefits of trade include increased competition, lower consumer prices for goods and services, and access to new markets. At the same time, a country may choose to enact trade restrictions to achieve certain policy objectives, such as to protect local industries or domestic labor. Excessive constraints can increase the costs for domestic firms using imported inputs or increase the costs for domestic exporters. This section will assess the Kyrgyz Republic’s official trade and investment regime.
The Kyrgyz Republic ranked 132 out of 167 countries in the World Bank’s aggregated Logistics Performance Index (LPI) 2012-2018, a benchmarking tool used to identify strengths and weaknesses of trade logistics. Among the comparator countries, only Tajikistan had a lower LPI (147) ranking during this period. Specifically, the Kyrgyz Republic had the lowest ranking relative to the benchmark countries in two out of the LPI’s six sub-indicators, including international shipments (157) and logistics competence (147).51
If trade is a binding constraint, then actors should experience customs and trade regulation costs that are higher than competitors. In the Doing Business Ease of Trading Across Borders, the country’s score increased from 70.7 in 2016 to 80.7 in 2019.52 The Kyrgyz Republic’s 2019 rank is fourth best and it performs in the top half with regards to the time burden and costs for exports (Table 4.2). However, the country does not perform as well with the import indicators. The country has the second longest time burden for the border compliance of imports (72 hours); the second highest cost for import documentary compliance ($200); and the highest cost for import border compliance ($512). In the Enterprise Survey, firms reported the second longest time burden to clear imports from customs (11.8 days).
51 The LPI international shipments sub-indicator measures the ease of arranging competitively priced shipments, while the logistics competence sub-indicator measures the competence and quality of logistics services. 52 The trading across border indicator is based on a possible score of 100.
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Table 4.2. The Time and Cost of Trade, 2019
Country
Time Burden of Compliance (hours) Cost of Compliance (US$) Exports Imports Exports Imports
Documentary
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Armenia 2 39 2 3 150 100 100 0 Georgia 2 6 2 15 0 112 189 396 Kyrgyz Republic 21 5 36 72 110 10 200 512 Lao PDR 60 9 60 11 235 140 115 224 Moldova 48 3 2 4 44 76 41 83 Nepal 43 56 48 61 110 288 80 190 Tajikistan 66 51 126 107 330 313 260 223
Source: World Bank Doing Business Report, 2019. If customs and trade regulations are a binding constraint, firms should be attempting to circumvent the costs or time burdens associated with official trade channels. Informal trade flows have played a significant role in the size and growth of the informal economy and ADB contends the value of informal trade may exceed formal trade flows (2014). According to the U.N. Development Programme (UNDP), informal trade is driven by poor trade infrastructure (e.g. few border stands; long lines), low limits for imported duty-free goods and a general lack of awareness of regulations (2016). Corruption may also drive private actors to informal trade as bribes and kickbacks are typically used to smooth out the process (ADB, 2014). There is thus some evidence that non-tariff barriers could be causing actors to bypass official trade channels.
Direct exports account for 13.8% of total sales for large firms, compared to only 3.8 and 3.6 percent of small and large firms, respectively. At the same time, 16.3 percent of large firms, 12.3 percent of medium firms and 10.4 percent of small firms identify customs and trade regulations as a major constraint. Therefore, the perception of customs and trade regulations does seem to worsen as firms gets larger. A firm’s exposure to foreign inputs does not correlate with the perception of customs or trade regulations. For example, small firms have the greatest use of foreign inputs at 72.5 percent, yet they account for the lowest percentage of firms identifying customs and trade regulations as a major constraint.
Another issue that is difficult to quantify but was occasionally raised during stakeholder interviews is the new compliance requirements of the EAEU. The recent accession to this trade body offers many opportunities to expedite border crossing and reach new markets, but it also requires new sanitary and phytosanitary certifications that some firms report being difficult to understand and comply with, particularly small-scale agriculture. Some of these issues will resolve with time, but it is too early to make a definitive assessment of the effects of EAEU accession on firms’ perceptions of customs and trade regulation. The upcoming Enterprise Survey should shed new light on this topic.
Overall, the evidence on customs and trade regulation shows that the Kyrgyz Republic performs poorly, particularly on import procedures, but these regulations are not binding. Shipping and
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logistics are particularly problematic, but border compliance times and costs are not unusual on the whole, and firms that rely heavily on foreign inputs do not identify customs and trade regulation to be too burdensome.
4.4 Conclusion The overall evidence provided in this chapter shows that the inconsistent and unreliable application of the law is the binding constraint to private sector economic growth and investment in the Kyrgyz Republic. Although the design of economic laws and regulations is generally good by international standards, particularly for a lower-middle income country, the poor application of the law significantly increases cost and risk to private business. This conclusion is supported by evidence from all four HRV tests:
Test 1: Shadow Price
The legal and regulatory cost to business is very high. The gap between the design and implementation of laws and regulations is wide, and many business people complain about the fickle nature of enforcement. High regulatory costs and unpredictability of regulation increase business risk and deter new investment.
Test 2: Movements in the Constraint
There is a strong correlation between political instability and economic growth rates in the Kyrgyz Republic. Moreover, anecdotal evidence from many stakeholders suggests that the high level of political turnover results in unpredictable enforcement. Issues such as tax enforcement and the impartiality of the legal system are subject to change depending on political considerations at the time.
Test 3: Circumvention
Circumvention of law and regulation is standard operating procedure for many businesses. Bribery and corruption is high. The Kyrgyz Republic has a large informal sector, and many formal businesses complain about unfair competition from informal firms. The widespread use of the patent system, while technically legal, is an indication of the strong incentives and institutional weaknesses in place that discourage both formal registration of businesses and their full participation in the tax system.
4. Camels and Hippos
The low level of foreign investment, particularly in the mining and hydropower sector given the potential opportunities that exist, is a clear indication that foreign businesses view Kyrgyz Republic as a risky and unpredictable economy. Uncertainty about the application of the law increases the risk associated with the appropriability of private returns from investment, particularly in the long term.
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MACROECONOMICS
Macroeconomic stability does not, by itself, ensure high rates of economic growth and poverty reduction. Rather, it is typically a prerequisite for investment and growth. Key tools for maintaining macro stability include counter-cyclical fiscal and/or monetary policies, appropriate investment and exchange rate regimes, and strong financial regulation and supervision. If macro stability is achieved and sustained, and if the public sector supports adequate infrastructure and human capital along with a business environment that enables trade, investment and innovation, then growth should follow.
Macroeconomic Stability in Kyrgyz Republic: Overview Macroeconomic stability is often characterized by low/stable inflation, a sustainable level of national debt, moderate fiscal deficits, and reasonable currency stability. In general, the Kyrgyz economy has, in recent years, demonstrated such stability. In the words of the End-of-Mission press release by the IMF Article IV team that visited Bishkek in March 2019:
“The economy of the Kyrgyz Republic grew by 3.5 percent in 2018, benefiting from a stable regional environment. Inflation at 1.5 percent on average for the year, a moderate fiscal deficit of 1.3 percent of GDP for 2018, gross official foreign exchange reserves at
Key Messages
• Macroeconomic stability is a precondition for sustained economic growth. In recent years, the Kyrgyz Republic has achieved a reasonable degree of macroeconomic stability with moderate inflation and fiscal deficits, currency stability, and a sustainable debt.
• Since independence, the Kyrgyz Republic’s growth has been impacted frequently by external or internal shocks. And with its heavy reliance on remittances and gold exports, the economy will remain vulnerable to external shocks until the private sector grows and becomes more diversified.
• Despite recent solid macroeconomic performance, there are challenges moving forward, including: keeping government expenditures and the overall fiscal deficits in check so as to maintain the fiscal space necessary to make needed investments in infrastructure and human capital; and maintaining an exchange rate consistent with both economic fundamentals and international competitiveness in the context of a heavily dollarized economy that is prone to Dutch disease impacts.
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4.0 months of imports53 and a stable banking sector point to the success of stabilization policies carried out by the government and National Bank of the Kyrgyz Republic.”
Clearly the Government of the Kyrgyz Republic has succeeded—at least for the time being—in achieving reasonable macroeconomic stability. And it follows that the lack of such stability is not, at present, a serious constraint to private sector investment and growth. But as in any country, there are macroeconomic policies that can be improved and related issues on the horizon that potentially threaten long term stability and growth. Several of these issues and challenges are reviewed below.
Macroeconomic Challenges
Growth and Inflation Volatility
The performance of the Kyrgyz Republic’s economy since independence in August 1991 offers insights into both the challenges and importance of achieving and maintaining macroeconomic stability. Before independence, some 98 percent of Kyrgyz exports went to the Soviet Union. With the breakup of its Soviet trading block, the loss of its export markets, and limited experience or expertise managing the economy, the Kyrgyz Republic went into a steep economic decline. Within five years of independence, real per capita GDP had fallen by more that 45 percent and annual inflation had risen as high as 32 percent. Since the mid 1990s, however, the management of the economy has steadied considerably with positive growth in most years and, with some exceptions, single digit inflation rates. (Figure 5.1)
53 A traditional “rule of thumb” is that countries should hold foreign exchange reserves equal to at least 100 percent of short-term debt or three months’ worth of imports. However, experience from the 2008 financial crisis suggests that such “one size fits all” guidelines may not be the most appropriate. Each crisis or shock is unique, and the impact of any single event can vary significantly from country to country. That said, the IMF now suggests that for low income countries, which typically have relatively limited access to capital markets, balance of payment drains result mainly from trade shocks, and volatile FDI and remittance flows. And for such countries the three months of import coverage remains a useful indicator of foreign reserve adequacy. In contrast, emerging markets can experience balance of payments drains due to a wider range of factors, including disruptions in debt flows and portfolio investment and capital flight. In this case, the IMF suggest using a country-specific “risk-weighted metric” to assess foreign reserve adequacy. Also, countries with good policies and strong institutions seem to need lower levels of reserves. For more details see IMF Survey, “Assessing the Need for Foreign Currency Reserves”, April 7, 2011. Over the past 10 years, Kyrgyz Republic’s average annual foreign exchange coverage of imports has ranged from 3 months in 2008 to 4.8. months in 2017, and had remained above four months since 2015.
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5.1. GDP Growth and Inflation (annual percentage)
Source: IMF, World Economic Outlook, October 2018
Rates of growth and especially inflation in Kyrgyz Republic since 2000 have been somewhat volatile relative to comparator countries (Figure 5.2)54. That volatility has for the most part resulted from shocks—such as declines in commodity prices, disruptions in the economies of key trading partners (such as Russia), or periods of domestic unrest within the Kyrgyz Republic itself—as opposed to serious mismanagement of the macroeconomy. In recent years, fiscal policy has been used more actively to dampen the adverse economic impact of such shocks as well as to advance other Government objectives. While this approach has generally worked, it does—as discussed in Section 5.2.2 directly below—pose potential risks to the long-term stability of the economy.
54 Volatility was especially pronounced between roughly 2008 – 2014 due to the global financial crisis, the 2010 revolution, and Russian sanctions.
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Figure 5.2. GDP Growth and Inflation Volatility (2000-2017)
Source: IMF, World Economic Outlook, October 2018
Fiscal Policy
As mentioned above, monetary and fiscal policies are typically key tools for managing a country’s macroeconomy. In the case of Kyrgyz Republic, the effectiveness of monetary policy is limited by the high rate of dollarization, the generally “thin” financial sector, and the limited monetization of the economy55. Thus, fiscal policy, which has mainly to do with how levels of government spending and taxation are adjusted so as to influence aggregate demand in an economy, is of particular importance.
As reflected in Figure 5.3, there have been distinct changes in the Government’s fiscal stance over the last two decades. 2000-2008 marked a period of fiscal consolidation, with government revenues increasing much more rapidly that expenditures so that the fiscal deficit declined from almost 11 percent of GDP in 2000 to reach a small fiscal surplus in 2008. Since then, however, the fiscal trend has been expansionary with the growth of government expenditures outstripping revenue and fiscal deficits hitting almost 6 percent of GDP in both 2010 and 2012 and averaging about 4 percent between 2008-2017.56 57 This is mainly because after the shocks of 2008 (the global financial crisis) and 2010 (the revolution) government spending on wages, pensions, and the social safety net increased. While effective in countering the negative impacts of shocks, these expenditures are now essentially locked into the budget even though the effects of the shocks have
55 In the Kyrgyz Republic, the relatively low ratios of bank assets/GDP and M2/GDP (where M2 is a broad definition of the money supply) are consistent with a thin financial sector and a low level of monetization. 56 The “right” size of a fiscal deficit depends on a number of factors, including the relation between actual and potential output in the economy and the rate of inflation. For example, the EU’s Stability and Growth Pact requires, at least in principle, that under normal circumstances a country’s fiscal deficit not exceed 3 percent of GDP. As a more general rule of thumb, deficits above 5 percent in an economy that is performing reasonably well may be problematic. 57 Ironically, in 2018 the Government tighten its fiscal policy more than the IMF recommended—ending up with a deficit of 1.3 percent of GDP.
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receded. Besides boosting the deficit (and public debt), this also means that there is less “fiscal space” and thus fewer government resources available for needed spending on human capital and infrastructure, for example.
Figure 5.3. Kyrgyz Government Revenues and Expenditures (percent GDP)
Source: IMF, World Economic Outlook, October 2018
A related problem is the sheer magnitude of the Kyrgyz Republic’s government sector. Specifically, government expenditures accounted for 38.7 percent of GDP in 2017, versus less that 30 percent of GDP in other comparator countries, except for Tajikistan which was 36.5 percent. Similarly, government revenues (at 33.4 percent of GDP in 2016 in Kyrgyz Republic) are well above the level of resources mobilized in other comparator countries except Tajikistan. Inefficiencies associated with Government public financial management and procurement systems, as well as the sheer size of the Government’s wage bill, suggest that some of the resources currently going to Kyrgyz Republic’s large public sector might be better used in the private sector.
Exchange Rate
The exchange rate, which reflects the rate at which a country’s currency can be exchanged for another’s, is an important macroeconomic variable58. It plays a key role in determining a country’s competitiveness in international markets, impacts investment decisions, and influences prices, employment, and aggregate demand in the domestic economy.59
58 Factors influencing exchange rates between countries’ currencies include: differentials in inflation and interest rates; the magnitudes of current account deficits and public debt; terms of trade (meaning the relative prices of imports and exports); and political and economic stability. 59 There are a variety of exchange rate regimes that countries can adopt—from floating (where rates are determined according to supply and demand in the foreign exchange market) to fixed (where countries intervene by buying/selling domestic/foreign currencies in the foreign exchange market so as to minimize variations in exchange rates). A floating exchange rates is desirable since the rate is market determined and thus reflects economic fundamentals, while a fixed or at least more stable exchange rate reduces the exchange rate risks that businesses and investors face.
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Kyrgyz Republic faces the same fundamental exchange rate challenge that confronts most countries—how to reflect economic fundamental while reducing instability and maintaining external competitiveness. But due to significant foreign exchange inflows from remittances and gold exports, the Kyrgyz Government must also worry about adverse Dutch disease impacts, especially reduced international competitiveness. At independence, the Government adopted, in general, a policy of floating exchange rates. And as shown in Figure 5.4, the Kyrgyz som has undergone significant nominal devaluation (against the U.S.$) since then.
Figure 5.4. Kyrgyz Som Exchange Rate, 1993-2018
Source: CDCData.com
However, since 2016 the som/U.S. dollar exchange rate has been, in the words of an economic expert interviewed by the IGD team, “suspiciously stable”. It is common knowledge that the National Bank has intervened in recent years on both sides of the foreign exchange market to reduce fluctuations in the U.S. dollar exchange rate.60 The Kyrgyz Republic holds significant U.S. dollar denominated external debt, and repayment will be easier in the absence of further devaluation of the som. In addition, China’s growing role as a supplier for Kyrgyz imports (and for goods that are re-exported for Kyrgyz Republic to other EAEU countries), together with the relatively close link between the U.S. dollar and the Chinese yuan, enhances the benefit to Kyrgyz Republic of a stable U.S. dollar/som exchange rate. Nevertheless, the IMF continues to advise the National Bank of Kyrgyz Republic that it should “allow the exchange rate to fluctuate in response to changing economic dynamics”.61
60 See World Bank, Kyrgyz Republic: Economic Update, Fall/Winter 2018, pp. 8 - 10 for more details 61 IMF press release following completion of 2019 Article IV mission to Kyrgyz Republic, March 20, 2019.
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Finally, both Kyrgyz Republic’s nominal effective exchange rate62 and its real effective exchange rate63 have appreciated in the past year (Figure 5.5). With inflation being consistently low in most countries, this is due mainly to the appreciation of the som against the currencies of key trading partners such as Russia and Kazakhstan. This recent trend has somewhat reduced the competitiveness of Kyrgyz exports.
Figure 5.5. Nominal and Real Effective Exchange Rates (index, 2010=100)
Source: World Bank, Kyrgyz Republic: Economic Update, Fall/Winter 2018
Government Debt
a. Public Debt: A macroeconomic problem that is potentially looming on the Kyrgyz Republic’s horizon is the sustainability of its public debt (external plus domestic). There are no hard and fast guidelines on how large a country’s public debt can be relatively to overall GDP before it becomes unsustainable. That depends on, among other things, the growth and structure of the economy, the government’s fiscal balance, the current account balance, and debt terms and maturity.64
62 The nominal effective exchange rate measures the value of a currency against a trade-weighted average of the foreign currencies of key trading partners. 63 The real effective exchange rate equals the nominal effective exchange rate adjusted for different price levels in trading partners. A country’s real effective exchange rate will increase if (ceteris paribus): a) its nominal effective exchange rate increases, or b) its rate of price inflation is higher than in trading partners. If a country’s real effective exchange rate is rising, then its goods are becoming more expensive relative to its competitors in foreign markets. 64 As a general rule, more developed economies are seen as capable of sustaining larger debts relative to their GDPs than are developing countries. For example, as of 2018 the average public debt/GDP ratio for advanced economies was 102 percent as opposed 50 percent for developing and emerging economies.
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The Kyrgyz Republic’s government gross debt to GDP ratio was about 60 percent in 2010, declined to 46 percent in 2013, rose back to 65 percent in 2015, before settling at 56 percent in 2017.65 It is projected by the IMF to decline toward 51.5 percent of GDP by 2022.66 Overall, the Kyrgyz Republic is judged by the IMF to be at “moderate risk of debt distress”.67 This does not mean that debt default is imminent or even likely in the future. But it does suggest that, in particular, the external debt outlook remains vulnerable to external shocks that impact exports and remittances (see below). The overall debt situation is another reason why, going forward, the Government will need to be mindful of resuming sustained fiscal consolidation.
b. External Debt: Developing countries typically have relatively small stocks of capital together with abundant investment opportunities with above average returns. In this context, and in the absence of inefficiencies and distortions, well targeted externally financed investments should contribute to growth. At some point, however, the burden of debt repayments becomes excessive and actually hinders growth by diverting resources from productive uses into debt repayments. As for public debt overall, whether or not a country’s external debt is too high depends on the structure and performance of the economy, and the strength of its institutions.68 Common indicators used by the IMF and others to assess the sustainability of a country’s external debt include the ratios of: 1) the present value of debt to GDP, and 2) and debt service to exports.69 70
As shown in Figure 5.6, Kyrgyz Republic’s external debt as a share of GDP has declined both over time and relative to other Central Asia comparators. This is due in part to the general growth and strengthening of the Kyrgyz economy and related institutions since independence, and (more recently) to cut backs in public investment and Russian debt write-offs. As of 2016, all baseline external debt indicators are below threshold levels (above which concerns re debt sustainability rise) over the 2017 – 2037 period. According to IMF modeling, serious issues concerning external debt sustainability are likely only in the case of a large external shock71.
65 Expansionary fiscal policy between 2010 – 2017 and a $300 million Russian debt write-off between 2015 -2017 accounted for much of the change in the gross debt/GDP ratio over this period. For 2018, gross debt/GDP for Kyrgyz Republic was 55 percent, while it was higher in Laos (67 percent), but lower in Armenia, Georgia, Moldova, Nepal, and Tajikistan at 53, 44, 33, 30, and 53 percent respectively. 66 See IMF, Kyrgyz Republic: Debt Sustainability Analysis, December 2017. 67 Source: IMF, Kyrgyz Republic, “Debt Sustainability Analysis Update”, December 2017. 68 See IMF, Review of the Debt Sustainability Framework for Low Income Countries, 2017 for more details. 69 Indicator thresholds (above which concerns rise about external debt sustainability) are higher for countries judged to have stronger institutions (as measured by Country Policy and Institutional Assessment (CPIA) indicators). That is, countries with stronger institutions are judged able to sustain higher levels of public or external debt. 70 When applying the debt sustainability framework to Kyrgyz Republic, the IMF adjusts debt indicators to account for the significant inflow of remittances into the Kyrgyz economy. 71 Another concern is the degree to which a country’s external debt is concentrated among a few bilateral creditors. This could give creditor countries undue influence over a borrower country’s foreign policy, or make the borrower particularly susceptible to currency swings.
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Figure 5.6. External Debt (percent GDP)
Source: Federal Reserve Bank of St. Louis
Diversifying the Economy
A final point to mention is the need to diversify the Kyrgyz economy. While not a narrowly macroeconomic issue, it does link with the challenges discussed above. With remittances equivalent to 30 percent of GDP, and gold exports from a single mine accounting for close to 40 percent of exports, the Kyrgyz economy is not well positioned to avoid or minimize the types of external shocks that have adversely impacted growth in the recent past. To achieve such diversification by growing its internal private sector, the Kyrgyz Republic will need to not only maintain a stable macroeconomic setting, but also address issues relating to the business and investment climate and governance that are discussed elsewhere in this report.
Conclusion
Macroeconomic stability provides a necessary foundation for a country’s growth and development. Over the past 25 years, the Government of the Kyrgyz Republic has made good progress in putting that foundation in place. During the team’s meetings in Bishkek, experts on the Kyrgyz economy described the current macroeconomic climate in Kyrgyz Republic as “benign”. It is clear that macroeconomic instability is not currently a binding, or even a serious, constraint to private investment and growth.
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MARKET FAILURES
Introduction Market failures are not a binding constraint to economic growth in the Kyrgyz Republic. The term “market failure” refers to a situation in which individual economic actors fail to provide goods and services that would otherwise be profitable or socially beneficial. Some market failures justify the existence of government programs to fill gaps in services that the private market fails to provide. For example, governments provide national defense and environmental protection because private actors do not have the financial incentive to provide these important and necessary services. We call these public goods. But market failures also exist in the private market. The production of goods requires a supply of both tradable inputs, such as raw materials, and non-tradable inputs, such as human capital, services, and infrastructure. As HRV describe in the IGD Mindbook, non-tradable inputs are particularly problematic because no individual person will supply a non-tradable input if there is no demand for it. This unique feature of non-tradable inputs results in two types of market failures: coordination failures and self-discovery externalities.
Coordination failure is the economic version of the chicken-and-egg problem. For example, a chemical company will not open a new production facility if there are no good chemists, but no university student will study chemistry if there are no chemical companies to work for. Here, the non-tradable input is human skills. The second type of market failure, self-discovery externalities, is a form of free riding problem because businesses and entrepreneurs must experiment and take risks in order to discover new products and services that can be made with the available supply of non-tradable inputs. However, no business will accept the risk and financial burden of market discovery if competitors can benefit from the discovery without bearing the cost. Intellectual property rights and patent laws are necessary to protect self-discovery and overcome this market failure. Effective institutional structures and proper legal protections will help overcome the coordination and information externalities that hinder the development of new and profitable investments.
Key Messages
• Market failures are not a binding constraint, and in fact, the Kyrgyz Republic performs relatively well in this area.
• The Kyrgyz Republic has a relatively high level of economic diversity and technological sophistication for its level of income and small market size.
• The current constraint to increasing the volume of exports lies in the number of markets exporters can reach rather than the number and types of goods they produce.
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Economic Diversification With a population of 6.2 million and a GDP of just $7.6 billion, Kyrgyzstan faces certain limitations to the diversity of its production and export basket. But market development and expansion is still necessary to create a dynamic and competitive economy, and the data suggest that Kyrgyzstan has done well for a country of its level of development. In fact, the data suggests that Kyrgyzstan’s economic complexity is ahead of other countries with higher levels of GDP and GDP growth.
To test for market failure constraints, we can use the economic complexity index (ECI) from the Observatory of Economic Complexity. ECI measures the amount of knowledge and the scale of networks necessary to produce goods. For example, the manufacture of optical instruments and electronic microcircuits requires broad networks of knowledge and suppliers to produce these goods. But on the other end of the spectrum, goods like raw cotton and fruit can be produced with less complex economies. As shown in the Table 6.1 below, Kyrgyzstan has the second highest ECI among comparators at -0.29 and ranks 68 out of 126 in the world.72 Countries like Tajikistan and Laos have much lower levels of ECI because they are more dependent on the production of raw materials and other less economically complex goods. However, despite Kyrgyzstan’s relatively high ECI, its GDP per capita is second lowest among comparators, and its average annual GDP growth of just 3.44% from 2013 to 2017 is the lowest. This data suggests that economic complexity is not a constraint to growth; Kyrgyzstan has failed to achieve high growth rates despite a relatively high level of economic complexity. Other constraints are holding back the economy.
Table 6.1. Economic Complexity ECI Rank (out of
126) GDP per capita
Avg. annual GDP per capita growth (2013-2017)
Georgia -0.06 63 4,057 4.3% Kyrgyzstan -0.29 68 1,220 3.4% Moldova -0.46 76 2,290 4.6% Tajikistan -1.10 109 801 4.6% Laos -1.25 115 2,457 5.9%
Source: Observatory of Economic Complexity
Product Space Analysis
The development of economic complexity over time can be visualized using product space mapping from the Observatory of Economic Complexity. The product space is a map of all goods exported worldwide and is developed using mathematical relationships between the
72 ECI values range from -2.0 to 2.3, with half of countries below zero and half above.
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quantities and types of goods exported around the world. For example, countries that produce men’s shirts are also very likely to produce men’s coats because these products use similar non-tradable inputs to production (such as a textiles factory and skilled textile workers). Conversely, there is no close relationship between men’s shirts and navigation equipment since the inputs are dissimilar. The product space hints at industries and products that a country may want to pursue to advance its economic complexity given its available non-tradable inputs and knowledge base.
The three images below show the development of the Kyrgyz product space from 2007, 2012, and 2017. Over that time, there has been some shifting of production capacity of the Kyrgyz economy. The product space mapping shows a simultaneous movement toward concentration in agro-industrial sectors (shown on the right side of the diagrams) and a diversification of the economy in industrial subsectors like machines, stone and glass, and plastics and rubbers. This trend is visible on the left half of the product space diagrams below. Importantly, these changes do not necessarily reveal additional growth in these sectors, but rather a diversification of the types of products exported.
As a small economy with a large gold and minerals industry, the product space mapping is somewhat limited in its usefulness because the export basket is heavily weighted to a few goods, and non-extractive exports only make up about $825 million, or 11 percent of total GDP. Gold and mineral products made up 45 percent of total goods exports in 2007, 48 percent in 2012, and 57 percent in 2017. The small size of the economy limits the number of goods that will be exported in any significant quantity. Given those limitations, there are a couple of important trends in the product spacing mapping shown in the Figures 6 series. First, the left half of the graph shows a slight increase in the number of products exported. These products are primarily related to chemicals, stone, plastics, and machinery. Products on this half of the diagram are more economically complex and typically provide higher value due to the technology, knowledge, and sophistication required to produce them. Products in this area of the diagram are more likely to drive the economy toward economic growth. Second, the product space reveals a decline in the number of exports on the right half of the diagram. The most common industries on this section are foodstuffs, vegetable products, and textiles. The decline in the number of products reflects mostly a concentration of exports into fewer goods rather than a decline in total value.
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Figure 6.1. Product Space 2007 ($1.18 billion; gold 20 percent; gold and mineral products 45 percent of total goods exports)
Figure 6.2. Product Space 2012 ($1.68 billion; gold 34 percent; gold and mineral products 48 percent of total goods exports)
Figure 6.3. Product Space 2017 ($1.92 billion; gold 39 percent; gold and mineral products 57 percent of total goods exports)
In terms of the number of products exported, Kyrgyzstan exports a large number of goods relative to the size of its economy. Kyrgyzstan ranks in the middle of the comparators in absolute terms (Figure 6.1) but highest in relation to GDP. As shown in Figure 6.2 below, for every one billion dollars of GDP, Kyrgyzstan exports 106 different products, the most among comparators. This is further evidence that the country has been effective at overcoming coordination and information externalities by producing a range of products despite its small economy. However,
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the small average export value of each different product raises concerns about efficiency and economies of scale.
Figure 6.4. Number of Products Exported
Source: UN Comtrade
Figure 6.5. Number of Commodities Exported per Billion Dollars of GDP
Source: UN Comtrade and WDI
Index of Export Market Penetration
Although Kyrgyzstan has done well in developing an export basket of goods, it lacks the ability to find a diverse set of markets. The ability of a country to diversify its export market opportunities is called export market penetration.73 According to the World Bank’s World Integrated Trade Solution (WITS), “A low export penetration may signal the presence of barriers
73 WITS: Export market penetration “measures the extent to which a country’s exports reach already proven markets. It is calculated as the number of countries to which the reporter exports a particular product divided by the number of countries that report importing the product that year.”
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to trade that are preventing firms from expanding the number of markets to which they export.” As shown in Figure 6.3 below, Kyrgyzstan ranks 127 out of 149 countries in export market penetration, which is an indication that Kyrgyzstan has much room to improve the number of markets to which it exports. Gold is clearly one of the major drivers of the low export penetration since this one commodity constitutes 37 percent of all exports ($713 million in 2017), and 91 percent of that gold is exported to just two markets: Switzerland and the UK. The low export market penetration is a constraint but also presents a clear opportunity for economic growth. The recent infrastructure improvements in the country and region, increased emphasis on regional economic integration, and the accession to the EAEU are all factors that could help improve market penetration in coming years.
Figure 6.6. Export Market Penetration
Source: WITS
Another measure of market penetration is the Herfindahl-Hirschman Product Concentration Index which measures the dispersion of trade value (as opposed to trade quantities) across export partners. Highly concentrated markets have values close to 1 while highly diversified markets have values closer to 0. Kyrgyzstan ranks in the middle of the comparators with a market concentration of 0.15, as shown in Figure 6.4. The Herfindahl-Hirschman score is better than the export market concentration score, but it still leaves much room for improvement and is an indicator of additional development opportunities available to Kyrgyzstan.
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Figure 6.7. HH Market Concentration (low values are best)
Source: WITS
Information Externalities The previous analysis in this chapter assessed the bindingness of coordination failures. To evaluate the second category of failures, information externalities, we test constraints related to intellectual property, patents, and R&D. Hausmann, et al. (2008) describe how developing countries do not need to reinvent technology since they are able to import it from other more advanced economies. However, the existence of technology is not sufficient to develop economic capabilities to provide that good or service; this requires experimentation, a process known as “self-discovery”.
A first test of information externalities is patent applications. Advanced, technologically sophisticated economies produce intellectual property and have legal structures to protect it. According to data provided by the UN’s World Intellectual Property Organization (WIPO), Kyrgyzstan produced 84 patents in 2016 (Figure 6.8) and has averaged 120 per year over the past decade. This is only slightly below Armenia and Georgia, which averaged 124 and 142 patents per year between 2009 and 2016. Figure 6.9 puts the number of patents in context of population and GDP. In terms of the number of patent applications per million people, Kyrgyzstan is positioned well above the trend line, which indicates it is more R&D focused than what would be expected based on its level of per capita income. The evidence in these charts provides further support that market failures are not a binding constraint to economic growth.
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Figure 6.8. Resident Patent Applications
Figure 6.9. Patent Applications per Million People
Source: World Intellectual Property Organization; WDI Another test for information externalities is the level of high-technology exports. The OECD has categorized all UN Comtrade product codes into four categories of technological sophistication from low to high technology. High-technology exports are defined as “products with high R&D intensity, such as in aerospace, computers, pharmaceuticals, scientific instruments, and electrical machinery.” The data here indicates that Kyrgyzstan has a highly technologically advanced export basket relative to its level of total exports and manufactured exports. As shown in Figure 6.10, high-technology exports as a percent of total exports is nearly 6 times higher than the second country, Armenia, and high-technology exports as a percent of manufactured exports are more than double Armenia (Figure 6.10). In fact, Kyrgyzstan ranks 43 out of 160 countries in the world in high-tech exports as a percent of total exports, which is further evidence that the country has developed a level of technological sophistication that is higher than expected given its level of income and relatively small market size.
Figure 6.10. High-Tech Exports as a Percent of Total Exports (left) and as a Percent of Manufactured Exports (right)
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One area where Kyrgyzstan does lag behind the comparators is in scientific and technical publications. Data from the National Science Foundation shows that Kyrgyzstan published just 17 scientific and technical journal articles per million people compared to 178 for Armenia, 155 for Georgia, 83 for Moldova, and 19 for Nepal (Figure 6.11). The low number of journal articles is probably less an indication of any market failure constraint than an indication of the human capital constraints resulting from the poor quality of the university education system.
Figure 6.11. Scientific and Technical Journal Articles per Million People.
Source: National Science Foundation, Science and Engineering Indicators, as reported in the WDI.
Summary
The available evidence indicates that market failures are not a binding constraint to economic growth in the Kyrgyz Republic. In fact, the Kyrgyz Republic has a relatively high level of technological sophistication and has developed a diverse and complex network of industries. This is especially true given the country’s small size and challenging geographic positioning. The challenge for Kyrgyzstan is to capitalize on its strengths and expand to new export markets. The continued development of high-technology goods and services will go a long way in achieving higher rates of economic growth.
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HUMAN CAPITAL
Summary The quality of the education system in Kyrgyzstan is an emerging constraint to economic growth, but it does not constitute a binding constraint at present. Although human capital does not rise to the level of certain microeconomic constraints (see Chapter 4) in terms of bindingness, the quality of the education system is very poor and must be drastically improved over the longer term if Kyrgyzstan is to maximize its economic growth potential. The population of Kyrgyzstan is nominally well-educated and government expenditure on education is high, but the effectiveness of the education system is severely lacking. Nearly all students achieve the basic standards of literacy and numeracy, but the education system fails to meet international standards of educational achievement and is unable to develop the advanced soft and hard skills required by the private sector. Low quality education has a direct impact on the development of the private sector because of low labor productivity and high levels of firm-level training.
Human capital is the stock of skills, knowledge, and health embodied in labor. For economies to grow, countries must expand the level of human as well as physical capital. Human capital is a constraint to economic growth if firms and entrepreneurs are unable to find, at a reasonable cost, skilled workers to meet the needs of their business and to attract new investment. Although human capital can always be improved, even in the highest income countries, human capital is a binding constraint only if the demand for skilled labor significantly exceeds the supply. In that case, investing in more human capital would alleviate the constraint. However, for economies with high levels of unemployment, and in particular high unemployment among workers with technical and tertiary education, the constraint lies on the demand side of the labor market. For human capital be a binding constraint, the HRV tests for human capital must reveal serious deficiencies on the supply side.
Key Messages
• Human capital is an emerging constraint but is not deemed to be a binding constraint at this time.
• Completion rates through the secondary level are high, but private sector firms find it difficult to find workers with the right skills.
• There are no measured financial returns to achieving a higher level of education, which is a further manifestation of the quality issues in the education system.
• Health outcomes are not a constraining factor, but a relatively high population growth rate will require faster rates of job creation in future years to keep unemployment low.
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If human capital is a constraint, we expect to see evidence of firms and workers behaving in certain ways to overcome the constraint. Firms will invest their own funds to train their employees and will invest more in capital-intensive production methods. Workers will invest in their own education rather than relying on the public education system because they know the investment will pay off with higher earnings in the future. Firms will look to hire more skilled employees from abroad and pay a premium for those skills. These topics are analyzed in the sections below.
Access to Education Access to education is not a constraint to economic growth in the Kyrgyz Republic. Basic education through the secondary level is nearly universal, and the literacy rate is above 99 percent for both men and women. National statistics show that 95 percent of the population has completed at least lower secondary education, and 88 percent has completed at least upper secondary. The government ensures that basic skillsets are developed for almost everyone, even if those skills are not very good by international standards.
The near universal access to education is a reflection of the government’s investment into the education system. As shown in Figure 7.1 below, government spending on education is the highest among comparators, both as a percentage of GDP (7.2 percent) and as a percentage of total government expenditures (18.5 percent) (Figure 7.1). However, values as a percent of GDP are not necessarily the best indicators of education spending since wealthier countries can spend a small percentage of their budget and still achieve higher expenditure per student. In absolute terms, Kyrgyzstan’s per capita education spending of $88 is in the middle range of the comparators, just about half of the wealthier comparators but approximately double Nepal and Tajikistan (Figure 7.2). These funding levels are healthy for a lower-middle income country.
Figure 7.1. Government Expenditure on Education (percent of total expenditure and percent of GDP)
Figure 7.2. Per Capita Education Spending
Source: WDI; author calculations
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Schooling, Enrollment, and Educational Attainment In terms of the number of years of schooling, the Kyrgyz Republic ranks highly by global standards with 10.7 years of total schooling on average. This is only 2.5 years behind the global leader, the United States, and is comparable to many upper middle- and high-income countries. However, the quality of those years is seriously in doubt. As shown in Figure 7.3 below, Kyrgyzstan is one of the largest positive outliers in the world when the years of education are mapped to GDP per capita.
Although there is a fairly strong correlation between education attainment and GDP per capita globally, the Kyrgyz Republic has not benefitted economically from its public investment in education. One might be tempted to interpret the results of the regression in Figure 7.3 as evidence that education is not a binding constraint because there appears to be an over-supply of education. And this would likely be true if the years of education in Kyrgyzstan were equipping students with the skills needed to be productive members of the workforce. However, numerous quantitative and qualitative sources point to the low quality of education. Thus the number of effective years of education is much lower than what the official statistics show, thereby weakening the argument that there is an over-supply of education.
Not only is the government spending 18.5 percent of its budget on an education system that is not generating good results, but the many years spent in education represent an opportunity cost of not working or not attending a high-quality school in which the financial returns would be higher. The constraint to higher educational achievement is not budgetary, at least not at the general level across all education levels; rather, it lies with administration, curriculum development, teacher quality, and other non-budgetary factors that are necessary for the development of an effective education system.
Figure 7.3. Average Years of Schooling and GDP per Capita
Source: Barro-Lee (2010 data) and WDI
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Concerns About the Quality of Education The poor quality of the education system is apparent in national and international assessments of educational attainment (Table 7.1). The poor results on these assessments begin in primary school and continue through the tertiary level. Kyrgyzstan ranked last out of 65 countries in the 2009 Program for International Student Assessment (PISA) on all three areas of evaluation: reading, mathematics, and science74 (note: 2009 is the latest data available; Kyrgyzstan did not participate in the 2012 and 2015 PISA, and it was the only comparator country to participate in 2009. Some education experts interviewed by the team confirmed that the government is planning to participate in the PISA again in future years).
Table 7.1. PISA Scores for Select Countries (2009 results) Reading Math Science
Russia 459 468 478 Bulgaria 429 428 439 Romania 424 427 428 Kazakhstan 390 405 400 Albania 385 377 391 Azerbaijan 362 431 373 Kyrgyzstan 314 331 330
Source: OECD
Whereas the PISA tests 15-year-old students, the National Sample Based Assessment (NSBA) tests students at grades 4 and 8 and suggests that the problems of the education system manifest themselves in the early years of schooling and continue forward from there.75 In the 2017 NSBA for grade 4 reading and comprehension, a full 60 percent of all students scored below basic and 25 percent scored at the basic level.76 Only 7 percent of students were at the advanced level. By grade 8, there is some catch up, but scores remain very poor: 52 percent are below basic, 17 percent are basic, 18 percent are advanced basic, and 14 percent are advanced. In terms of math performance, the grade 8 NSBA showed that 65 percent of students were below basic, 18 percent are basic, and just 2.9 percent are at the advanced level. Natural science scores were even lower with 77 percent of students below basic and just 0.4 percent advanced.
The problems continue at the vocational and tertiary level. As the European Training Foundation (ETF) describes, “employers express high expectations of their graduates but asses their quality as very low”.77 There is also a widespread belief that corruption is a major issue in the university system, and many students are able to buy exam results and diplomas despite poor performance.
74 http://www.oecd.org/pisa/46643496.pdf 75 ETF, Transition from School to Work in Kyrgyzstan, Results of the 2011/12 Transition Survey, Prepared by Arne Baumann, Eva Jansova, and Ellu Saar, 2013. 76 All NSBA results are as reported by UNICEF in a forthcoming paper, Kyrgyz Republic: Education Sector Analysis—Strategic Choices for the Government to Improve Education. 77 European Training Foundation, 2012. Anticipating and Matching Skills Demand and Supply: Synthesis of National Reports.
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Although it is impossible to get official statistics on corruption practices, the ETF and education specialists in Kyrgyzstan frequently cite corruption as a major issue. A 2013 World Bank corruption survey found that 48% of respondents paid a bride for educational services, which is third highest among government services behind police (61 percent) and judiciary (52 percent).78
Education and Gender One of the few strengths of the Kyrgyz education system is gender parity as it pertains to access to education and basic skills attainment. Men and women have equal access to education opportunities, which is a longstanding trend that dates to the Soviet era. Both women and men have over 99 percent literacy, and educational enrollment is nearly identical for men and women. The school enrollment gender parity index (GPI) shows that equal percentages of girls and boys enroll at the primary and secondary levels, and more women than men enroll at the tertiary level (Figure 7.4). The GPI is consistent with the comparators; only Tajikistan shows a major gender parity gap. Women have in fact become more educated than men and are more likely to pursue higher levels of education beyond the secondary level. As shown in Figure 7.5 below, men are more likely to suspend their education at the secondary level (56 percent of men compared to 45% of women). Women are much more likely than men to continue their education to the secondary professional and higher professional levels. A total of 42.3 percent of women complete either secondary professional or higher professional education compared to just 25 percent for men.
Figure 7.4. School Enrollment Gender Parity Index (GPI) by Education Level
Source: UNESCO Institute for Statistics
78 World Bank, 2016, Do the poor pay twice? Impact of Corruption in the Kyrgyz Republic: A Poverty and Social Impact Analysis. http://documents.worldbank.org/curated/en/846411476572605922/pdf/109235-WP-P160444-PUBLIC-KYR-Poverty-and-Corruption.pdf
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Figure 7.5. Education of the Workforce by Gender
Source: NSCKR
Enrolled students by stage (basic, secondary, tertiary) over time One of the most important trends in education over the past 25 years in the Kyrgyz Republic is the rapid increase in the number of students pursuing tertiary education. This has important implications for the labor market since it is not clear that there are sufficient jobs to absorb the new entrants. As shown in Figure 7.6 below, since Kyrgyz independence, the number of graduates from higher educational institutions79 has risen over 500 percent, and the number of students completing secondary special education has doubled (the values are indexed so that all values in the start year of 1990 are equal to 100). Meanwhile, there has been essentially no change to educational attainment at the lower secondary, upper secondary and vocational levels.80
79 Specific definitions of these terms, as defined by the NSCKR, are available in a methodological appendix here (Russian only): http://stat.kg/en/statistics/download/methodology/117/ 80 While higher education has grown the fastest, it is important to keep in mind that this classification had the lowest number of graduates in 1990. In that year, 5% of all graduates were classified as finishing higher educational institutions while 42% had finished secondary school (9 grades). By 2016, 20% of all students finished higher education and 36% secondary (9 years).
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Figure 7.6. Index of the Number of Graduates by Level of Education (1990=100)
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Tertiary and TVET Education While additional education is generally encouraged, the statistics on higher educated presented above suggest that that Kyrgyzstan’s population may be overeducated for the types of jobs that currently exist in the labor market and that educational resources are misaligned with the needs of the private sector. In their 2012 report, the ETF estimates that “the number of higher education graduates could exceed the potential domestic employment demand by up to 50 percent.” A research paper on youth employment from the University of Central Asia Institute of Public Policy and Administration also concluded that education mismatches are a growing problem in the country. The authors specifically identify an over-supply of graduates in law and economics while there is a shortage of skills from professional technical colleges in sewing, cooking, electrical, welding and automotive.81
In an effort to improve the TVET system, the GoK reorganized its TVET agencies in 2015 by consolidating the initial VET (IVET) and secondary VET (SVET) agencies under control of the Ministry of Education and Science. This was the first time that IVET, SVET, and higher education agencies were united under a single ministry.82 It is too early to determine how effective the changes will be in employment outcomes and whether the reorganization will result in meaningful policy changes.
81 Tilekeyev, Kanat, et al., 2018, Analysis of youth labor market trends in Kyrgyzstan and an assessment of youth labor market opportunities in selected project locations, University of Central Asia. 82 ETF Torino Summary 2016-2017.
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Economic Returns to Education An important test of education as a binding constraint is to look at the financial returns to education. This test is known as a Mincer regression. In theory, if human capital is in limited supply (relative to demand) in a well-functioning market economy, then there will be a high wage premium for those people who do have high levels of human capital. If human capital is in abundant supply, then the wage premium will be lower. One of the most commonly cited studies on Mincer regressions across countries is Montenegro and Patrinos (2014); however, the only data from Kyrgyzstan is from 1997 and so is probably not a fair reference to the current state of the education system and labor market. For what it is worth, this report did show some positive returns of 8. percent overall, 5.6 percent for secondary education, and 7.0 percent for tertiary education (returns above 10 percent are considered high). However, more recent survey data suggests that the returns to education have disappeared. In an alarming result, the most recent household survey data shows no statistically significant difference in wage level between different levels of education. This result is confirmed by the ETF and by the author’s own calculations using the Life in Kyrgyzstan survey data set. The UCA IPPA report also found that “Young employees who have a higher education and a college degree and work in small businesses such as sewing factories, construction, and companies operating in the service sectors, have similar salaries to the uneducated youth.”83
The authors of this report calculated their own Mincer regression results using a modified form of the regression based on a categorical variable for education level rather than the years of education. This was necessary because the Life in Kyrgyzstan survey does not ask for the number of years of education, only the level (basic, primary technical, secondary technical, and university). The results for a variety of regression controls showed the same result: no statistically significant difference in wage earnings based on level of education (the dataset excludes migrant labor).
The fact that there are no returns to education at all is difficult to explain, but one theory posited by the ETF is that people with tertiary education are more likely to go into government work, which provides lower salaries than the private sector. Public servants are not well paid. For example, teachers are paid $198 per month (13,800 som), which is below the overall average wage of $216.84 As the ETF writes, “Surprisingly, the education level seems to have a relatively weak impact on the average monthly wage…The salary of labour market entrants with general secondary education is somewhat higher compared to all other educational groups. However, it should be noted that 85 percent of young people with general secondary education were working in the private sector, while about two-thirds of labour market entrants with higher education were employed in the public sector.”
83 Tilekeyev, et al. 2018 84 UNICEF, forthcoming
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One important caveat is that the survey only includes people who hold a formal sector wage job; it does not survey people who work in the informal sector, which is a substantial part of the economy. Since formal jobs tend to pay more than informal jobs, and formal employment is more likely with higher levels of education, the Mincer results are likely biased against higher levels of education. In other words, the study’s exclusion of lower paid informal workers could artificially lower the wage gap (and therefore any return to higher education).
Employment Outcomes by Education Level In addition to higher wages, higher levels of human capital are expected to reduce unemployment rates. Low unemployment suggests a high demand for labor as well as a proper matching between the skills demanded and the skills supplied. High unemployment could be the result of several factors including an economic recession, the inability of firms to find capable workers, or a high reservation wage of workers. The latest ILO data for Kyrgyzstan shows that unemployment rates fall drastically between basic education and intermediate education, but they flatline between intermediate and advanced education (Figure 7.7). The decline in unemployment from basic to secondary education suggests there is some return to completing secondary education, but only 7.9 percent of the population fails to complete high school. Since the vast majority of Kyrgyz students complete secondary education, the data is consistent with the Mincer regression and finds no significant improvement in labor outcomes for higher educated workers. Importantly, women do benefit from advanced education; their unemployment rate falls from 9.7 percent to 6.8 percent while the unemployment rate for men actually increases from 7.8 percent to 8.4 percent. Overall the total unemployment rate for
Methodology to estimate private returns to education: The Mincer Regression* One way to measure if firms are paying a high premium for educated workers is to estimate the returns to additional years of schooling using a Mincer regression. In very simple terms, a Mincer regression uses household survey data to measure the effects of an additional year of education on wages, while controlling for other individual characteristics. Typically, the equation estimated is: lnW= β0 + β1 Si + β1 Ei + β2 E2i + e Where W = Hourly wages (measured as a logarithm) S = Completed years of schooling E = Potential years of labor market experience E2= a squared experience term to account for lifecycle earnings Once the equation is estimated, β1 may be interpreted as the percentage change in earnings for an additional year of schooling. Anything higher than 10% private return to one additional year of schooling is considered high, and may indicate a binding constraint. *Adopted from USAID’s IGD for West Bank and Gaza, 2017.
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workers with advanced education is marginally improved relative to workers with secondary education--from 7.8 percent to 7.6 percent.
Figure 7.7. Unemployment by Educational Level
Source: ILOSTAT (2013 data)
Education Level of Migrants With low returns to education, it is plausible that more Kyrgyz workers with advanced education would move overseas to find better paying work. However, the evidence shows that migration is not higher for those workers with a university degree compared to those with a secondary degree. To test for migration, we look at a question from the Life in Kyrgyzstan study that asks if workers have moved either internationally or internally in the previous 12 months. As shown in Figure 7.8 below, international migration (show in the blue bar) is highest among those with secondary general and secondary technical education. Nearly 12 percent of all working-age survey respondents with secondary education reported moving abroad in the previous 12 months compared to 4.7 percent who migrated internally. However, if we look at workers with higher levels of education at the secondary technical and university level, we see almost no gap between the levels of international and domestic migration.
The gap between international and internal migration serves as a marker of how attractive international migration is for a worker with that particular education level. While the benefits of international migration are more pronounced for secondary general education, those workers with more advanced education are either more content with job market opportunities domestically, would prefer not to work overseas (primarily service jobs in Russia), or are unable to find work abroad due to the poor quality of their skills. The results could also be due to survey bias. Comparing migration patterns across education levels is only a fair test of constraints if we assume that workers across all four education levels are equally likely to move back to Kyrgyzstan and be surveyed. For example, if university graduates move abroad, they may be more likely to permanently live abroad and thus be excluded from the survey.
0
5
10
15
20
25
Basic Intermediate Advanced
Female
Male
Total
96
Figure 7.8. External and Internal Migration by Education Level
Source: LiK Survey
Migration is becoming an increasingly common job strategy for younger workers. Migration data since 1990 shows that the age distribution of migrants has narrowed and skewed more to workers in their late teens and 20s (Figure 7.9). Whereas the age distribution between 1990 and 2010 was largely unchanged, the five years from 2010 to 2015 showed a much more drastic change as more young people migrated abroad. The trend has important implications for inclusivity because it is younger workers who are most attracted by foreign work. This could be due to the inability to find work domestically, higher wages abroad, and the relative flexibility that younger workers experience since they are less likely to be married and have children.
Figure 7.9: International Migrant Stock by Age
Source: IOM
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
Basic SecondaryGeneral
SecondaryTechnical
University
Migrated Abroad in Last12 Months
Migrated Internally in Last12 Months
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
0-4
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20-2
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-29
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435
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445
-49
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455
-59
60-6
465
-69
70-7
475
+
1990
2010
2015
97
Stakeholder Perceptions A final test of education constraints is firm perceptions of workforce skills. The Enterprise Surveys ask firms to identify if an inadequately educated workforce is either the biggest constraint or a major constraint to their business. The results of the latest surveys for each comparator country are below. Kyrgyzstan is clearly one of the most education-constrained economies among the comparators. As shown in Figure 7.10, 33.5 percent of all firms identify an inadequately educated workforce as a major constraint to their business, and 6.8 percent identify it as the biggest constraint. While the 6.8 percent is only the fifth most commonly identified constraint (behind political instability, informal sector competition, corruption, and tax rates), it is the second highest among comparators behind Moldova. These results are a clear indicator that education in Kyrgyzstan is relatively more constraining to the private sector than in the comparator countries.
Figure 7.10: Percent of Firms Identifying an Inadequately Educated Workforce as a Major Constraint (left graph) and the Biggest Obstacle (right graph)
Source: Enterprise Survey
The major driver of workforce issues does appear to be the quality of the labor force and the appropriateness of worker skillsets. The UCA IPPA report states, “One of the most significant gaps found during the study is the gap between curriculum and labor market requirements. Educational institutions often teach according to an approved curriculum, but in real (practical) life this is far from what businesses require from specialists. According to business responses companies often retrain new employees according to their own standards. In their opinion, the youth often do not meet the demands of the employers and initial training is necessary to equip new employees with the required skills and knowledge.”
98
Indeed, the Enterprise Survey results show that Kyrgyz firms are much more likely to offer formal training to their workers than comparator countries (Figure 7.11). 62.7 percent of all firms offer formal training, which is nearly double the percentage of the second highest comparator, Tajikistan, at 33.1 percent. Interestingly, it is the services sector, not the manufacturing sector, which drives the survey results. 76.5 percent of retail service firms and 67.9 percent of non-retail services firms offer training compared to 47.2 percent for manufacturing.
Figure 7.11: Percent of Firms Offering Formal Training
Source: Enterprise Surveys
Health The final analysis of the human capital chapter is the effect of health outcomes on private sector growth. There is no significant constraint to the private sector due to the health of the population. Overall health outcomes are typical for middle income countries, and life expectancy is about average for the comparators. As shown in Figure 7.12, the life expectancy of 70.3 years places Kyrgyzstan in the middle of the comparators, and life expectancy improvements since 2005 are on par with the comparators. Kyrgyzstan life expectancy suffered after independence from the Soviet Union, and there was actually no increase in life expectancy between 1991 and 2007. But the country has since recovered and is progressing at a typical rate.
99
Figure 7.12: Life Expectancy (years)
Source: UN Population Division
One area where Kyrgyzstan does stand out from comparators is the relatively high fertility rate. While the poorest of the comparators, Laos and Nepal, have seen drastic decreases in fertility over the past several decades, the fertility rate in Kyrgyzstan (3.1 births per woman today) has actually risen since its lowest point in 2002 (2.4 births per woman). While the reasons for this increase are outside the scope of this report, there are important economic implications in the rising birthrate, particularly for the growth of the labor force and the need for job creation. As the population pyramid begins to expand outward, more and more young people will enter the workforce and need jobs. The population pyramid, shown in Figure 7.14, shows an unusual double expansion period whereby the population grew up until the collapse of the Soviet Union and then sharply contracting in the decade following independence. Population growth has since increased. Figure 7.13: Fertility Rate
Source: UN Population Division
50
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65
70
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80
19911993
19951997
19992001
20032005
20072009
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2015
ARM
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KGZ
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NPL
GEO
ARM
MDA
100
Figure 7.14: Population Pyramid of Kyrgyzstan
Source: Populationpyramid.net
Conclusions This chapter provides evidence that the quality of the Kyrgyz education system is an emerging constraint to economic growth. The results of the HRV tests are mixed, so there is insufficient evidence to categorize human capital as a binding constraint. The Kyrgyz population is nominally well educated, but the low quality of the education system means that it is not producing students with the skills required to be internationally competitive in their academic scores or to meet the skill needs of the private sector. Despite the fact that the average Kyrgyz student spends 10.7 years in school, firms are highly constrained by the inadequately educated workforce and spend a disproportionate amount of time and money training workers. That being said, given the low quality of the current education system, there is no benefit to workers attaining higher levels of (low quality) education. On average, both wages and unemployment rates are the same for those with intermediate levels of education and those with advanced levels of education, which is a sign of the low quality of tertiary educated workers. It appears that firms are able to bypass their human capital constraints in the short term by making a concerted effort to train their workers, but poor education quality and poor matching of skillsets to jobs are significant risks to Kyrgyz economic growth in the long term.
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INFRASTRUCTURE Key Messages
• Infrastructure is not presently a binding constraint to economic growth in the Kyrgyz
Republic. • Domestic transport infrastructure is a challenge, particularly roads. There is overall low
road density and many local roads are of poor quality. However, the evidence that this is a binding constraint on private sector growth is too mixed, with many “transport” delays emanating from inefficient implementation of regulatory requirements (e.g. customs or other inspections), not the infrastructure itself.
• There has been inadequate maintenance of electricity generation capacity and a lack of new investment, despite natural advantages in hydropower. Both trends are exacerbated by a below cost recovery tariff policy. Despite this, electricity shortages are not yet common.
Introduction This chapter provides an overview of the strengths and weaknesses related to the Kyrgyz Republic’s infrastructure, including its electricity, transportation networks, and information and communications technology (ICT). After performing diagnostic tests on each one of these topics, none presented conclusive evidence as being a current binding constraint to growth.
Though the domestic road network has clear issues, the evidence is too mixed for it to be found a binding constraint. Furthermore, many of the delays and costs associated with transportation appear to be due to inefficient implementation of regulatory requirements, such as customs or other inspections—in other words, not due to the physical transportation infrastructure itself. The Kyrgyz Republic’s electricity sector is burdened by aging assets and a mismatch between tariff revenues and the cost of delivering energy that discourages private investment, together implying that this sector may become a constraint to growth if tariff reforms are not implemented. Port, air, rail, and water infrastructure all have issues but do not rise to the level of a constraint. ICT infrastructure is a bright spot, with relatively high internet and mobile phone usage.
Infrastructure promotes broad-based economic growth through the creation and management of public goods that are beneficial to all segments of society. Roads, for example, provide a key conduit for goods and services that help reduce costs for businesses and consumers who have wider access to international markets. Infrastructure also has a direct impact on poverty reduction, as it provides increased opportunities for income generation, improved access to public services, and improved linkages between rural and urban markets. At the same time, there are many different facets of a country’s infrastructure and problems in any of them can cause significant barriers to economic growth.
102
Electricity
Sector Overview
The Kyrgyz Republic has near universal access to electricity (99.9 percent in 2016) with electrification rates similar to Armenia, Georgia, and Moldova and higher than Laos (87 percent) and Nepal (91 percent). The Kyrgyz Republic’s current installed generation capacity is 3,781 MW and the electricity supply is concentrated in hydroelectric (81 percent) and thermal generators (19 percent). The industry has several issues related to the supply of energy, including an expanding gap between generation capacity and electric demand during severe winters and aging assets. According to the World Bank, for instance, 45 percent of generation capacity is beyond its useful life (2018).
In the late 1990s, the Kyrgyz Republic enacted reforms to denationalize and privatize the electricity industry. In addition to incorporating the state-owned Kyrgyzenergo as a joint stock company (JSC), the reforms unbundled the electric industry by function (i.e. generation, transmission and distribution) to create six power companies, 16 wholesale electricity buyers and resellers, and 21 private distribution companies. In the 2000s, there were failed attempts to reform the electric industry based on the principles of full cost-recovery and constant service delivery. More recently, reform efforts have focused on improving regulation, the financial viability of the industry, and changing the tariff structure. In 2014, the Kyrgyz Republic went from a net exporter of electricity to a net importer (World Bank 2017).
In 2017, Kyrgyz Republic’s cumulative energy sector debt accounted for 19.6 percent of GDP compared to 11.4 percent of GDP in 2014. The debt is being driven by technical and non-technical electrical losses and by the mismatch between residential tariff revenues and the cost of delivering electricity. In other words, the tariff structure is below cost recovery—the electric sector’s tariff revenues are below the cost of service by approximately 7 percent (World Bank 2018).85 To begin to address this issue, the electric industry has recently reduced electrical losses and tariffs have increased marginally. However, household expenditure on electricity and the residential tariff rate (1.48 cents per kilowatt hour (kWh)) is lower than most countries in Eastern Europe and Central Asia. Although the residential tariff is only 37 percent of non-residential electricity tariffs, the Kyrgyz Republic also has one of the lowest tariff rates for non-residential customers at 4.01 USD cents per kWh (World Bank 2017). In the World Bank’s Doing Business Reliability of Supply and Transparency of Tariff Index, the Kyrgyz Republic is tied for the lowest score (0 out of 8) with Nepal and Tajikistan.86
85 This gap of only 7 percent was primarily due to high exports in 2017. Without exports, the gap would have amounted to 16 percent. As recently as 2014, the cost recovery gap was 32 percent. 86 The index is based on a scale of 0 – 8 with 8 indicating total reliability of supply and tariff transparency. The indicator does not disaggregate between these two issues.
103
Shadow Price of Electricity
Electric generators are used as a secondary source of energy in situations where there is no electric connection or when the connection in unreliable, such as when there are severe power outages during the cold winter months. Since generators are expensive and inefficient to operate, widespread ownership and usage provides an indirect measurement of a high shadow price of electricity.
A reliable electric connection is typically measured by the frequency and duration of power outages.87 Between 2009 and 2012, the Kyrgyz Republic’s distribution providers reported around 2 outages per hour across their networks (World Bank 2017). In the World Bank’s Enterprise Survey, 73 percent of Kyrgyz firms experienced a power outage within the last year—the highest of comparators, followed by Tajikistan (65 percent), Laos (55 percent) and Nepal (53.4 percent). It is worth noting, however, that the data collection phase for the last Enterprise Survey in the Kyrgyz Republic lasted from July 2012 to August 2013. In the middle of this period, December 2012, the Kyrgyz Republic experienced its worst set of blackouts in recent memory due to a breakdown at the Toktogul hydropower plant. It would be interesting to see how this data point evolves in the next Enterprise Survey.
Considering this idiosyncrasy, and that electrical outages were rarely mentioned as an issue during the team’s interviews, it is worth briefly examining other indicators of power outages. Figure 1.1 shows how the Kyrgyz Republic ranked in the median for the average number of outages per month (0.9 outages), and the average duration of an outage (3.7 hours) was only longer than Laos (2.4 hours). In addition, the country’s firms experienced average losses of 3.5 percent of annual sales due to outages, a figure that was lower than Nepal (17.2 percent) and Tajikistan (9.3 percent). According to the U.N. Economic Commission for Europe (UNECE), in 2016 the Kyrgyz Republic made improvements to energy infrastructure that resulted in a 10 percent reduction in power outages (2018).
87 A reliable electric supply is also measured by fluctuations in voltage, frequency or harmonics. According to the World Bank, the Kyrgyz Republic electricity system has voltage and frequency fluctuations.
104
Figure 8.1. Electrical Outages Figure 8.2. Generator Ownership and Usage
Source: World Bank Enterprise Survey, 2013 and 2016. A little over 39 percent of Kyrgyz Republic’s firms own or share a generator, which is second only to Nepal at 50.5 percent. While the percentage ownership of generators is quite high, the portion of electricity coming from generators is the median of its comparators. Of firms that are using a generator, an average of 8.3 percent of their electricity usage is supplied by that generator. This figure is lower than Laos (71.8 percent), Nepal (41.3 percent), and Tajikistan (16.7 percent). Anecdotally, the team heard from businesses that though they may own generators for backup capacity, they rarely have to turn them on. The high ownership and relatively low annual usage may be explained by a significant share of firms owning generators for backup use only during the winter months when the electric connection is less reliable.
Impulse Response of Electricity and Economic Growth
Studies have assessed the co-integration and causality relationship between energy consumption and growth to determine if there is a short- or long-term relationship between these two factors. Bildiric and Kayikci (2015) use energy and GDP data from 1992 to 2010 to perform a Granger causality88 test for certain regional economies, including the Kyrgyz Republic. In the short-term, the causality results demonstrate unidirectional causality from energy consumption to growth in each of the countries. In the long-term, there is a bidirectional causality between energy consumption and economic growth. Halis and Korap (2015) performed a Granger causality test to determine the relationship between electricity energy consumption and income. Their results demonstrate unidirectional causality from energy consumption to real GDP growth in the long-term. In other words, both studies present some evidence that data on energy consumption can help explain GDP growth figures.
88 Granger Causality: Variable X causes variable Y if Y can be better predicted using the histories of both X and Y than it can using the history of Y alone.
0.31.0 0.9 0.9
0.3
8.7
6.1
2.73.3
3.73.3
8.6
3.6
6.9
0123456789
10
Armenia Georgia KyrgyzRepublic
Lao PDR Moldova Nepal Tajikistan
# of Outages or
Hours
Number of electrical outages in a typical monthIf there were outages, average duration of a typical electrical outage (hours)
9.7
28.6
39.1
3.47.5
50.5
33.3
5.3 2.28.3
71.8
4.9
41.3
16.7
0
10
20
30
40
50
60
70
80
90
Armenia Georgia KyrgyzRepublic
Lao PDR Moldova Nepal Tajikistan
% of firms or % from generator
Percent of firms owning or sharing a generatorIf a generator is used, average proportion of electricity from a generator (%)
105
Although several studies evaluate the relationship between access and growth, the country has near universal coverage. Further, these studies do not evaluate the relationship between the reliability of the supply of electricity and growth. Figure 1.4 compares the quality of the electricity supply relative to a country’s wealth, indicating that the quality of the Kyrgyz Republic’s electricity supply is above the expected level for a country with its income level. Although the secondary evidence from Halis and Korap (2015) demonstrates a positive diagnostic test result for the impulse response of electricity and growth, Figure 8.3 indicates that the quality of the country’s electric supply does not presently appear to inhibit growth.
Figure 8.3. Electric Quality vs. GDP Figure 8.4. Profitability by Sector
Source: World Economic Forum, World Bank Doing Business Indicators and UNIDO.
Circumvention and Electricity
Firms own or share a generator to circumvent the absence of an electric connection or an unreliable electric connection. One of the biggest constraints to the Kyrgyz Republic’s electricity industry is a reliable supply, especially during the winter months when electricity demand accounts for 67 percent of annual demand (due primarily to electric heating demand) and hydroelectric supply can be constrained by slow water flows (World Bank 2017). As noted in the discussion around Figure 8.2, generator ownership or sharing is second highest among the comparator countries, but the proportion of electricity coming from generators is substantially lower than Laos, Nepal, or Tajikistan. 89
Electricity and Profits by Sector (Camels and Hippos)
This analysis considers the cost structure and profitability of firms in three different sectors to determine if firms less intensive in the use of electricity are more profitable than firms requiring greater electrical usage. The U.N. Industrial Development Organization (UNIDO) used firm-level data to compare certain cost and performance variables of food and beverage, textile and
89 More granular data could be used to estimate generator use by month, which would help to determine if generator use and ownership is higher during certain times of the year.
ARM
GEO
KGZ
LAO
MDA
NPL
TJK
y = 1.0575x - 5.2116R² = 0.7175
1
2
3
4
5
6
7
8
6 7 8 9 10 11 12
Ele
ctri
c Su
pply
Qua
lity
(1 -
7)
GDP per Capita, PPP (2011, Constant)
100% 80% 60% 40% 20% 0%
KGZ MDA
Food and Beverages
KGZ LAO
Textiles
KGZ VNM
Wearing Apparel
106
apparel companies in the Kyrgyz Republic, Laos, Moldova, and Vietnam. In the Kyrgyz Republic, electricity accounted for the smallest share of total production costs across each sector, due to Kyrgyz energy tariff policy.90 Electricity’s percentage share of total production costs was highest for apparel firms, followed by textiles, and then food and beverage (2018).
Assuming the (apparel) manufacturing sector requires larger electricity inputs than the (food and beverage) services sector, the assessment considered the profitability of each sector to determine if food and beverage firms were more profitable than the manufacturing sector. In the Kyrgyz Republic, apparel firms had the highest net profit margin, while firms in the textile and food and beverage sector had similar profit margins (Figure 8.4). Therefore, there is no evidence that firms less dependent on electricity are outperforming more electricity-dependent firms in Kyrgyzstan.
Transport Sector Overview
The Kyrgyz Republic’s remote location and topographic features present challenges for the efficient movement of goods and services. The country’s rugged terrain increases the cost of inputs and contributes to spatial disparities due to limited access to markets and services. The Kyrgyz Republic’s mountainous terrain shapes the transport network with most transport occurring on roads. Figures 8.5 and 8.6 demonstrate the long distances and high costs that firms need to incur to export their goods to markets and to obtain inputs. In 2014, for instance, the Kyrgyz Republic’s exports traveled the greatest distance and had the highest costs relative to all other reporting countries. Similarly, the country’s imports cost more and traveled greater distances than other reporting countries. Despite this, the country has a relatively high trade intensity, as explored in the “Distance to Markets” section of the Natural Capital chapter.
Figure 8.5. Export Distances and Costs Figure 8.6. Import Distances and Costs
Source: World Bank LPI, 2014.
90 Total production costs consisted of raw materials, fuel, electricity and labor.
GEO
KGZ
NPL
y = 0.9961x + 893.77R² = 0.3855
0
1000
2000
3000
4000
5000
0 500 1000 1500 2000 2500 3000 3500 4000
Cos
t to
Expo
rt (U
S$ p
er c
onta
iner
)
Export Distance (km)
GEO
KGZ
LAO
NPL
y = 1.1095x + 1007.8R² = 0.427
0
1000
2000
3000
4000
5000
0 1000 2000 3000 4000
Cos
t to
Impo
rt (U
S$ p
er c
onta
iner
)
Import Distance (km)
107
In 2014, the ADB concluded that the country’s transport infrastructure is not a binding constraint to growth; however, the World Bank identified transport infrastructure bottlenecks as one of five secondary constraints to growth in the 2018 Systematic Country Diagnostic. In the 2018 Logistics Performance Index (LPI), the Kyrgyz Republic had the third highest overall rank (108th out of 160) and fell within the middle (103rd) of the comparators for the LPI Infrastructure Sub-index.91 However, the country had a poor ranking (112th out of 140) in the 2017-18 WEF Global Competitiveness Index (GCI), which was only higher than Nepal (117th).92 Among reporting comparator countries, the Kyrgyz Republic had the lowest score for the quality of its ports and railroads and the 2nd lowest score for its roads and airports (Figure 8.8). In the Enterprise Survey, 4.1 percent of firms identified transportation as the biggest obstacle to doing business and 13.9 percent identified it as a major constraint (Figure 8.8). These percentages roughly fall within the middle of the comparator countries, indicating that domestic transport infrastructure is likely not a binding constraint.
Source: World Bank LPI; Enterprise Survey, 2013 and 2016.
Around 95 percent of passenger traffic and over half of freight transport is carried by road, including southbound freight to China. The Kyrgyz Republic has 34,000 km of roads. Of this total, the Ministry of Transport and Communications (MOTC), the country’s lead transport agency, maintains 4,163 km of international roads, 5,678 km of national roads, and 8,969 km of provincial roads. Other secondary, rural, and urban road networks are maintained by local government agencies. Relative to its comparators, the Kyrgyz Republic fell in a cluster with low
91 The LPI infrastructure indicator measures the quality of a country’s trade and transport infrastructure, including the quality of its ports, roads, railways and IT. 92 For the 2018 WEF GCI infrastructure indicator, the Kyrgyz Republic ranks 107th.
0.0
1.0
2.0
3.0
4.0
5.0
Quality of overallinfrastructure, 1-7
(best)
Quality of roads, 1-7(best)
Quality of railroadinfrastructure, 1-7
(best)
Quality of airtransport
infrastructure, 1-7(best)
Quality of portinfrastructure, 1-7
(best)
Armenia GeorgiaLao PDR MoldovaNepal TajikistanKyrgyz Republic
8.2
0.4
12.5
1.5
13.2
2.7
13.9
4.1
14.6
4.2
23.4
4.1
31.7
5.1
0 10 20 30
MajorConstraint
BiggestObstacle
% of Firms
NepalLao PDRMoldovaKyrgyz RepublicGeorgiaTajikistanArmenia
8. 7 Perceptions of Transportation 8. 8 WEF Infrastructure Scores
108
road density, having just 18 km of roads per 100 square km of land area. In this respect, it is similar to Lao PDR (17 km), Tajikistan (19 km), and Nepal (20 km). Armenia (27 km), Moldova (28 km), and Georgia (29 km) represent a higher tier of road density (CIA World Factbook).
One third of the country’s international and national road are in poor condition and need reconstruction or rehabilitation. The remaining two-thirds of the Kyrgyz Republic’s road networks are in sustainable condition, requiring only routine maintenance. Of the roads maintained by MOTC, 39 percent are paved, and 61 percent are unpaved. International roads, accounting for 22 percent of all MOTC-maintained roads, are generally in good condition and over 70 percent are paved. In contrast, local and national roads are in poor condition and have low traffic volumes.93 Over 60 percent of national roads and 75 percent of local roads are unpaved (ADB 2014).
The Kyrgyz Republic has 417 km of railway in operation, including separate northern and southern sections that account for roughly 75 percent and 25 percent of the overall network, respectively. The country’s Customs Agency manages airport road, rail freight, and customs stations, including 8 border crossings. Since the 1990s, the overall importance of rail transport for people and freight has declined. The freight volumes via rail networks have stagnated or fallen, while overall trade volumes have increased. Although the country’s railways currently have excess capacity, much of infrastructure is at the end of its commercial life (ADB 2014). Despite direct connections to Kazakhstan and Uzbekistan, there are no domestic rail connections between the northern and southern population centers nor externally with China. Table 8.1 shows that the Kyrgyz Republic has one of the smallest railway infrastructures in the region.
Table 8.1. Railroad Network, 2013
Country
Railway Length in Operation
(km)
Gauge (mm)
Passengers Transported (million)
Transport Volume (million-
passenger-km)
Freight Transported (million
ton)
Freight Transport
Volume (million-ton-km)
Number of Staff
Afghanistan 75 1,520 0 0 1.86 NA NA Azerbaijan 2,066 1,520 2.52 612 21.8 7,371 22,886 Georgia 1,994 1,520 2.73 550 16.67 4,947 12,700 Kazakhstan 14,205 1,520 20.5 18,300 275.3 216,500 76,240 Kyrgyz Republic 417 1,520 0.32 43 7.38 1,010 5,131 Mongolia 1,810 1,520 3.3 1197 21.12 12,473 13,364 Pakistan 7,791 1,676 47.69 19,779 1.61 1,090 80,054 Tajikistan 680 1,520 0.46 20 6.81 448 5,770 Turkmenistan 2,313 1,520 6 1,685 25 11,547 18,701 Uzbekistan 4,593 1,520 17.3 3,673 65 22,918 58,239
Total 35,944 – 100.82 45,859 442.55 278,304 293,085
Source: Central Asia Regional Economic Cooperation (CAREC), 2016.
93 While poor road quality may discourage use, it is also possible that low use discourages investments in upgrading quality. The relationship between quality and use is likely endogenous.
109
The Kyrgyz Republic’s other common mode of transportation is air travel. The country has 11 airports with 4 receiving regular international flights. Although the country’s airport facilities need upgrading, the current infrastructure has adequately supported growing passenger volumes. From 2000 to 2017, for instance, passenger volumes increased by an average of 12.3 percent per year, and, in 2017 the country’s airports had nearly 1.5 million passengers. According to the National Statistical Committee, waterways were not used for transport in 2018. Therefore, they were not further considered in this analysis.
Shadow Price of Transport
Since roads and rail are the primary means for transporting goods, an indirect measurement of the shadow price of road and rail travel is estimated by the proportion of products lost during transportation. In the Enterprise Survey, Tajikistan has the highest proportion of product loss due
to breakage or spoilage (4.3 percent), followed by the Kyrgyz Republic (1.0 percent), Laos (0.8 percent) and Moldova (0.1 percent) (Figure 8.9). International rankings also provide an indirect measurement of the time and costs associated with a country’s transport infrastructure. Although the country’s GCI ranking for the quality of its road network has improved from 131st in 2016-2017 to 122nd in 2017-2018, it still has one of the lowest rankings in the world and scores only better than Moldova (Figure 8.10). Similarly, Figure 8.7 shows how the Kyrgyz Republic had the 2nd lowest score for airport infrastructure, representing a country rank of 120th in 2017-2018. While the Kyrgyz Republic had the 2nd lowest score for railroad infrastructure, it ranked 76th out of all reporting countries.
Tajikistan 4.3
Kyrgyz Republic
1.0 Lao PDR0.8 Moldova
0.7Nepal
0.7Georgia
0.4Armenia
0.1
Prop
ortio
n of
Pro
duct
Val
ue (%
)
131 131
122
60
70
80
90
100
110
120
130
140
2015-2016 2016-2017 2017-2018
Cou
ntry
Ran
k (0
to 1
38)
Year
Armenia Georgia Kyrgyz RepublicLao PDR Moldova NepalTajikistan
8. 10 Road Network Rankings 8. 9 Products Lost to Breakage or Spoilage
Source: Enterprise Survey, 2013 and 2016; Logistics Performance Index.
110
Statistics on the region’s transport corridors also provide a measurement of the time burden and costs for transporting goods along the Kyrgyz Republic’s road networks. Regional transportation statistics are maintained by the Central Asia Regional Economic Cooperation (CAREC) program, a partnership of 11 countries to promote economic and social development in member countries. CAREC maintains and monitors speed, cost and customs data for six CAREC road corridors. Of the six CAREC routes, road corridor 1, 2, 3 and 5 passes through the Kyrgyz Republic. In 2011, the median speed at three of these corridors (1, 2 and 3) exceeded the median for all corridors (40 km per hour) (Figure 8.11).
However, the average speed substantially decreased when transit delays were considered, including delays for customs clearance and inspections (2011). According to ADB, the relatively high-speed travel times (without delays) for corridors 1, 2 and 3 indicated that the Kyrgyzstan’s infrastructure was performing adequately while costs were driven by microeconomic constraints like regulations (ADB 2014). Although total travel costs were mostly higher in 2016 than 2011, those costs were primarily caused by microeconomic constraints like customs and non-tariff barriers (CAREC 2016).
Source: CAREC, 2011 and 2016.
Impulse Response of Transport Infrastructure and Trade
Although few assessments have considered the direct relationship between transport infrastructure and growth in the Kyrgyz Republic, several studies have focused on this relationship transport in a regional context. Specifically, assessments have estimated the potential impact of the Belt and Road Initiative (BRI), a strategic effort proposed by China to enhance connectivity and cooperation along the old Silk Road and in certain maritime corridors.
$919
$474
$664
$927
$1,621
$785
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
$1,800
0
10
20
30
40
50
60
1 2 3 4 5 6U
S$ p
er 5
00 k
m.
Corridor
2016
Speed (no delays) Speed (with delays)
$529 $523 $515
$1,441
$1,198
$690
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
$1,800
0
10
20
30
40
50
60
1 2 3 4 5 6
Km
. per
hou
r
Corridor
2011
Speed (no delays) Speed (with delays)
8.12. CAREC Speeds and Costs, 2011 8.11. CAREC Speeds and Costs, 2016
111
The World Bank estimates the impact of BRI on trade for Central Asian countries, including the expected reduction in shipment times and trade costs for the Kyrgyz Republic, by using geographic data and network algorithms between city pairs. Assuming certain improvements to transport infrastructure, the projections demonstrate significant improvements to shipping times and a reduction in trade costs ranging from 1.5 to 2.8 percent. Moreover, the Kyrgyz Republic and Kazakhstan show the most potential for reduced shipment times as a result of improved corridor management (2018). Similarly, RAND Corporation performed an econometric analysis to assess the potential of BRI to eliminate soft (e.g. logistics) and physical trade barriers in Central Asia. There findings demonstrate “a positive and statistically significant association between transport infrastructure and connectivity and bilateral trade,” including positive results for the Kyrgyz Republic.94
Figure 8.13 also compares the quality of a country’s road network to its level of wealth, showing the quality of the Kyrgyz Republic’s road network is below the expected level for a country with its income level. Similarly, Figure 8.14 shows the quality of the Kyrgyz Republic’s airport infrastructure is below the expected value for a country with its income level. Although not shown here, a similar test was performed for rail infrastructure demonstrating that the quality of the Kyrgyz Republic’s rail infrastructure was at the expected level for a country with its income level.
Source: World Development Indicators and World Economic Forum.
Circumvention and Transport Infrastructure
Countries generally invest in special economic zones to strengthen value chains, establish clusters, and bypass constraints in the local economy. In the Kyrgyz Republic, there are currently
94 It should be noted that the authors were not claiming a causal relationship between the variables.
ARM
GEO
KGZ
LAO
MDA
NPL
TJK
y = 0.667x - 1.822R² = 0.5383
0
1
2
3
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5
6
7
6 7 8 9 10 11 12
Air
Qua
lity
(0 -
7)
GDP per Capita, PPP (2011, Constant)
ARM
GEO
KGZLAO
MDA
TJK
NPL
y = 0.6353x - 1.919R² = 0.4867
0
1
2
3
4
5
6
7
6 7 8 9 10 11 12
Roa
d Q
ualit
y (0
-7)
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Figure 8.13. Road Quality and GDP Figure 8.14. Airport Quality and GDP
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two types of special economic zones, free economic zones (FEZs) and high-tech industrial parks. The country is also in the process of setting up industrial parks to promote textiles. There are 5 FEZs situated close to border areas, although 99 percent of FEZ exports originate from the FEZ in Bishkek, implying that domestic transportation infrastructure from Bishkek to the border is adequate. From 2014 to 2017, the country’s high-tech virtual park has expanded 3-fold in terms of sales volume and personnel.
Although the Kyrgyz Republic set up the FEZs to bypass a number of constraints, including transport infrastructure, there is no evidence to indicate that transport was one of the primary motivations for its creation. According to the U.N. Development Programme (UNDP), one reason individuals give for engaging in informal trade is to circumvent poor trade infrastructure at the border, including a limited number of border stands and long lines (2016). There are thus mixed findings regarding the circumvention of transport infrastructure by economic actors.
Transport Costs for Non-Exporters and Exporters
The analysis considers several factors – perceptions of trade as an obstacle to doing business, losses due to breakage and spoilage, and sales growth or capacity utilization – for non-exporters and exporters to determine if firms less intensive in the use of transport are more profitable than firms requiring greater transport. For firms where exports account for 10 percent or more of direct exports, the Kyrgyz Republic had the lowest percentage of firms (0 percent) identifying transport as the biggest obstacle to doing business (Figure 8.15). Similarly, the country’s exporting firms experienced transport losses amounting to only 0.2 percent, a figure that is lower than Nepal (1.1 percent), Georgia (0.8 percent), Tajikistan (0.4 percent). This implies that despite the country’s distance from markets, exporters do not see transport infrastructure as a challenge for growth.
Evidence from the country’s non-exporting firms tell a slightly different story. Of the comparator countries, Figure 8.15 shows that the Kyrgyz Republic’s non-exporting firms had the 2nd highest proportion of firms identifying transport as the biggest obstacle to doing business (4.6 percent). Moreover, the country’s non-exporting firms reported trade losses amounting to 1.2 percent of the product value, a figure that was only lower than the 4.7 percent of trade losses experienced by Tajikistan’s non-exporters (Figure 8.16). This is potentially reflective of the more poorly-maintained regional roads that are likely more important for non-exporting firms.
113
Source: World Bank Enterprise Survey.
Ports
Summary of Findings
According to the 2017-18 GCI, the Kyrgyz Republic has one of the lowest quality port infrastructures in the world and ranks below all the comparator countries (Figure 8.17), though all but one of these landlocked comparators (Georgia) are clustered near the bottom of the ranking. Again, with the exception of Georgia, the quality of the Kyrgyz Republic and its comparators’ port infrastructure falls below what would be expected for countries with similar income levels (Figure 8.18).
Source: World Economic Forum (2017-18) and World Bank Development Indicators, 2016.
1.3
31.6
02.3
16.7
9.5
00.31.9
4.6 4.2 3.65
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10
15
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35
Armenia Georgia KyrgyzRepublic
Lao PDR Moldova Nepal Tajikistan
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4.5
5.0
Armenia Georgia KyrgyzRepublic
Lao PDR Moldova Nepal Tajikistan
% o
f pro
duct
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ue
Breakage / Spoilage
ExporterNon-exporter
137 135 132 127 126 125
69
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40
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160
KyrgyzRepublic
Nepal Tajikistan Lao PDR Moldova Armenia Georgia
Qua
lity
of p
ort i
nfra
stru
ctur
e (r
ank)
ARM
GEO
KGZ
L…MDA
NPL
TJK
y = 0.7112x - 2.6344R² = 0.4601
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8. 16 Product Value Lost to Transport 8. 15 Biggest Obstacles to Business
8. 17 Quality of Port Infrastructure 8. 18 Port Infrastructure and GDP
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In 2016, the time burden for outbound freight to pass through the country’s CAREC corridor border points fell below the 50th percentile when compared to all other border crossings in the region (Figure 8.19).95 The time burden for inbound traffic fell below that 75th percentile (Figure 8.19).96 The time burden for both inbound and outbound traffic is caused by long wait times due to customs and regulations (e.g. phytosanitary, border security, health, etc.).
The average cost for inbound freight fell below the 50th percentile97 for all border crossings. While the average cost for outbound traffic at four out of five border crossings fell below the 50th percentile, the cost at the Kyrgyz Republic’s Irkeshtan border crossing was 2nd highest among all regional border crossings with an average cost of $343 (see highlighted data in Figure 8.20).98 The costs at the Irkeshtan border crossing are driven by road tolls, customs clearance, and weight/standard inspection. For other border crossings, the outbound and inbound costs are driven by border security, customs clearance and other trade regulations (phytosanitary, veterinary inspection, visa / immigration, transport inspection, etc.).
Figure 8.19. Travel Times for Freight Figure 8.20. Travel Costs for Freight at CAREC Corridor Border Crossings at CAREC Corridor Border Crossings
Source: Central Asia Regional Economic Cooperation (CAREC) Program
95 CAREC provided the time burden for outbound freight at four border crossings. The longest average time was 3.7 hours at Karmik, followed by Batken at 2.1 hours and 0.2 hours for Ak-Tilek and Torugart. 96 CAREC provided the average time burden for inbound freight at five border crossings: Irkehtan (5.7 hours); Chaldovar (5.2 hours); Torugart (1.9 hours); Karamik (0.6 hours); and Ak-Tilek (0.2 hours). 97 CAREC provided average costs for outbound freight at four border crossings: Karamik (US$ 75); Batken (US$ 48); Ak-Tilek (US$ 14); and Torugart (US$ 18). 98 CAREC provided average costs for inbound freight at five border crossings: Irkehtan (US$ 343); Chaldovar (US$ 75); Torugart (US$ 37); Karamik (US$ 31); and Ak-Tilek (US$ 12).
Irkeshtan
115
Although there is mixed evidence regarding the extent to which port infrastructure constrains growth, the CAREC data implies that the issue with port “infrastructure” is not the infrastructure itself, but the regulation and operation of it. Given this, it is possible to conclude that port infrastructure is not a binding constraint to growth.
Information and Communications Technology
Overview and Summary of Findings
The Kyrgyz Republic has expanded access to information and communication technology (ICT), including access to the internet and mobile phones (EBRD 2015). For example, internet users increased from around 17 percent of the population in 2011 to 38 percent in 2017. As of 2013, nearly all businesses had computers with 39 percent using the internet and 9 percent owning their own websites (ADB 2014).
In the 2016 WEF Global Information Technology Report (GITR) Network Readiness Index, a measurement of a country’s ability to utilize ICT to support economic growth, the Kyrgyz Republic ranked 98th out of 143 countries and fell within the middle of all comparator countries. In the 2017-2018 WEF GCI, the Kyrgyz Republic had the second-highest country ranking for mobile telephone subscriptions (131 per 100 people) and ranked in the middle of the comparator countries for the percentage of individuals using the internet (34.5 percent). Figures 8.21 and 8.22 demonstrate how both the rate of internet users and cellular subscriptions in the Kyrgyz Republic is above the expected level for a country with its income level. Based on the country’s recent performance in global indicators, ICT is not considered a binding constraint to growth.
Source: World Development Indicators and World Economic Forum.
ARM
GEO
KGZ
LAO
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y = 21.097x - 144.46R² = 0.8061
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rnet
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rs (%
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20
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140
160
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8.22. Internet Use and GDP 8.21. Mobile Use and GDP
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Water
Overview and Summary of Findings
Most of the Kyrgyz Republic’s water supply and sanitation (WSS) infrastructure was built around 50 years ago and has deteriorated significantly. In addition, the sector is saddled by insufficient maintenance and poor service delivery. Although it is difficult to collect quantitative information regarding the performance of the country’s WSS infrastructure, the ADB has estimated the severity of several key issues, including:
• There is 60-90 percent urban water supply coverage; 50-60 percent rural water supply coverage;
• Reduced hours of supply (e.g. water supply ranges from 4 to 20 hours in cities); • Water losses amounting to 45 percent of supply; and • Low sewerage coverage, including less than 50 percent in cities and less than 25 percent
in rural areas (2014).
Two separate set of variables are used to evaluate the impact of WSS infrastructure on the Kyrgyz Republic. First, the portion of the country’s irrigated agricultural land is compared to all other reporting economies to determine if the country’s agricultural production is severely constrained by the water infrastructure. In 2016, the Kyrgyz Republic ranked 18th out of 36 countries with 9.5 percent of its agricultural land irrigated (Figure 8.23). This figure falls between Armenia and Laos, the only comparator countries reporting on this indicator. The second set of variables is related to the number and frequency of firms reporting water inefficiencies in the Enterprise Survey. With 12 percent of the country’s firms experiencing water insufficiencies, the Kyrgyz Republic falls within the middle of the comparator countries. Additionally, the country was tied for the 3rd highest number of water insufficiencies at 0.5 per month (Figure 8.24). While the Kyrgyz Republic WSS infrastructure does seem to pose some challenges, there is not enough evidence to qualify it as a binding constraint.
117
Source: World Bank Development Indicators and Enterprise Survey, 2013 and 206.
Conclusion The overall evidence from this chapter suggests that infrastructure is not a binding constraint to growth in the Kyrgyz Republic. To be sure, there are challenges, particularly in domestic transport infrastructure and inadequate maintenance of electricity generation capacity. Local and national roads are of poor quality and overall road density is low, creating challenges for rural market access. Perhaps surprisingly due to its significant distance from markets, Kyrgyz exporters do not see transportation infrastructure as a major issue99 - rather, it is infrastructure-adjacent implementation of regulations that increases cost and risk to the private sector. Electricity is not a pressing issue for firms at present, though generation assets have deteriorated due to minimal maintenance of existing plants and limited installation of new capacity. There is also some evidence of de facto rationing through long waits for new commercial connections, a trend that would likely worsen in the absence of new investment. In sum, the electrical infrastructure is not a current constraint and has no reason to be given the hydropower potential of the country. Despite this, the governance-related binding constraint may continue to restrain investment.
99 Further, as noted in the natural capital chapter, trade intensity is relatively high.
LAO, 12KGZ, 10
ARM, 9
0 10 20 30 40 50 60% of total agriculture land
Rep
ortin
g C
ount
ries,
2016
17.1
13.312.1 12.0
5.3 4.82.3
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20
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Georgia Moldova Armenia
Num
ber
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# of water insufficiencies per month (right axis)
8.24. Irrigated Land 8.23. Water Insufficiencies
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NATURAL CAPITAL
Key Messages
• Natural capital is not a binding constraint for the Kyrgyz Republic.
• The Kyrgyz Republic has the natural resources it needs for potential growth in the hydropower and mining sectors.
• Though the country faces high transport costs due to its landlockedness and mountainous topography, its relative high trade intensity implies that this is not a major concern for economic growth.
This chapter explores the natural capital endowments of the Kyrgyz Republic, including land resources, mineral and natural resources, water resources, biodiversity, climate change and environmental risk, and distance to markets. Though the Kyrgyz Republic faces several challenges related to natural capital—including its landlockedness, mountainous topography with little arable land, and lack of significant oil or gas deposits—the country also has the natural resources it needs for success in major sectors, particularly hydropower and mining. As a result, natural capital does not rise to the level of a binding constraint.
Agricultural Land Resources Kyrgyz agriculture, though still a major employment sector, suffers from relatively low productivity.100 To develop an efficient agricultural sector that can take advantage of economies of scale, arable land should be readily available. In examining the data, it is clear that though the Kyrgyz Republic does fall within the lower rungs of comparator countries with 6.7 percent of its territory arable land; only its relatively small population gives it a higher rank in terms of hectares of arable land per person (Figure 9.1).
100 World Bank Group, “Kyrgyz Republic: From Vulnerability to Prosperity, A Systematic Country Diagnostic,” 2018, pp. 43-46.
119
Figure 9.1. Arable Land in Kyrgyz Republic and Comparators, 2016
Source: World Development Indicators
Throughout interviews, particularly in Osh, the team regularly heard about the challenges of limited land suitable for crop production and the difficulty of competing with agricultural imports from Uzbekistan and other countries that can produce at scale. That being said, livestock production is less dependent on arable land and can instead utilize the country’s large supply of mountain pastures and meadows, which cover 48 percent of the Kyrgyz Republic’s territory.101
Mineral & Natural Resource Wealth Natural resources are an important contributor to growth in the Kyrgyz Republic, with natural resource rents outpacing all comparators but Laos (Figures 9.2 and 9.3). Specifically, mineral resources are prominent, with large reserves of gold, mercury, clay, coal, fluorspar, gypsum, lime, and silver.102 The country is heavily reliant on the Kumtor gold mine, which accounts for approximately 10 percent of GDP and 40 percent of exports by value. Though the private operator and Kyrgyz government budget have benefited from the mine’s production, there have been ongoing disagreements about the allocation of rents between the parties.103 This mine is currently scheduled to end production in 2026, with no replacement yet in sight.104
101 CIA World Factbook, Land Use - Permanent Pasture. https://www.cia.gov/library/publications/the-world-factbook/geos/kg.html 102 Renaud, Karine. “The Mineral Industry of Kyrgyzstan.” U.S. Geological Survey Minerals Yearbook, 2013. 103 Pomfret, Richard. “Exploiting a natural resource in a poor country: The good, the bad and the ugly sides of the Kyrgyz Republic’s gold mine.” IOS Working Papers No. 372. May 2018. 104 Kumtor Gold Company, Production. https://www.kumtor.kg/en/about/faq/production/
120
Source: World Development Indicators However, that does not appear to be due to lack of potential. The government is working actively to attract new investments in the sector,105, and the country has potential for additional large-scale mining operations. In addition to the minerals that are currently mined, there are also as yet unmined deposits of bauxite, copper, iron ore, lead, rare-earths, sulfur, tin, tungsten, and zinc.106 Anecdotally, an industry expert told the team that the Kyrgyz Republic possesses the natural resource endowments for four to five additional large-scale mining operations with potential production of over half a billion dollars per year each. If true, this could increase GDP by as much as 50 percent.
Water Resources With over 8,000 glaciers, the Kyrgyz Republic has significant water resources. Given this abundant water endowment, the country is able to generate the majority of its electrical needs through hydropower, which accounts for 81 percent of generation capacity. That being said, there remains significant undeveloped potential in the hydropower sector and under-maintenance of existing generation assets, as noted in the chapter on infrastructure.107 The World Bank has flagged the hydropower sector as a major opportunity for the country, referring to its potential as “huge.”108
To fill the present gap in hydropower generation infrastructure and to provide an additional source of heating in the winter months,109 the country has an outsize reliance on coal (Figure 9.4). In addition to the large coal-fired district heat and electricity plants in Bishkek and Osh,
105 The Embassy of the Kyrgyz Republic in India, Major Economic Sectors. http://www.kgzembind.in/?page_id=256 106 Renaud, Karine. “The Mineral Industry of Kyrgyzstan.” U.S. Geological Survey Minerals Yearbook, 2013. 107 World Bank Energy and Extractives Global Practice, “Analysis for the Kyrgyz Republic’s Energy Sector,” May 2017, pp. 8, 12. 108 World Bank Group, “Kyrgyz Republic: From Vulnerability to Prosperity, A Systematic Country Diagnostic,” 2018, pp. 47-50. 109 Hydropower production is typically lower in winter months due to lower discharge.
9. 3 Total Natural Resource Rents 9. 2 Natural Resource Rents, by source
121
about 40 percent of Kyrgyz urban households rely on inefficient and polluting coal-fired stoves or boilers. Use of these devices increases coal consumption by 20 to 30 percent over more efficient models.110
Figure 9.4. Carbon Dioxide Emissions from Solid Fuel (Coal)
Source: World Development Indicators
Biodiversity The remote mountainous geography of the Kyrgyz Republic supports a high level of biodiversity. With more than 90 percent of the country above 1,000 m altitude, the country is a collection of fragile mountain ecosystems with unique plants and animals. There are a number of endemic plants and animals, including 10 endemic species of fish in Lake Issy-kul. More than half of the country is potential snow leopard habitat, with an estimated population of 150-500,111 about 10 percent of the world total.112 Given that the country falls within a center of origin for domesticated fruit and nut crops, there is genetic richness found in wild-growing fruit-and-nut forests, which could represent possible sources of pest- and disease-resistant varieties for cultivated plant species, including apple, pear, cherry, plum, pistachio, and almond.113 Some of these potentially valuable species are at risk; one recent study highlighted risk to the endangered wild apple relative malus niedzwetzkyana.114
110 Balabanyan, Hover, Finn, and Hankinson. “Keeping Warm: Urban Heating Options in the Kyrgyz Republic.” The World Bank Group, March 2015, p. iii. 111 Snow Leopard Trust, Kyrgyzstan. https://www.snowleopard.org/our-work/where-we-work/kyrgyzstan/ 112 Cruise, Adam. “How a Hunting Reserve Became a Snow Leopard Sanctuary.” National Geographic, June 15, 2016. 113 Chemonics International for USAID Central Asian Republic Mission, “Biodiversity Assessment for Kyrgyzstan,” June 2001, pp. II-1 to II-5. 114 Wilson, Brett, Morena Mills, Maksim Kulikov, and Colin Clubbe. “The future of walnut–fruit forests in Kyrgyzstan and the status of the iconic Endangered apple Malus niedzwetzkyana.” Fauna & Flora International, March 7, 2019.
122
Climate Change and Environmental Risk There is some concern in the Kyrgyz Republic about the country’s exposure to the effects of climate change. In particular, there is concern about how it will affect glacial retreat and water supply, and the follow-on impacts on agricultural lands, livestock grazing, and hydropower. However, the data does not seem to support a high level of concern in the near term—relative to its comparators, the country is significantly less vulnerable to climate change, and has moderate readiness for any changes (Figures 9.5 and 9.6).
Figure 9.5. Climate Change Readiness Figure 9.6. Climate Change Vulnerability
The Notre Dame Global Adaptation Index (ND-GAIN) measures both a country’s vulnerability to climate-related risks and its readiness to leverage investments and convert them to adaptation actions. ND-GAIN assesses vulnerability by assessing the potential impacts of climate change on a country’s water, food, health, ecosystems, human habitats, and infrastructure. The Kyrgyz Republic ranks 68 out of 181 countries in terms of vulnerability and is notably the highest-ranked low-income country in this respect. Adjusted for GDP, it is the 3rd-ranked country in the world, following only Ukraine and Belarus. ND-GAIN measures readiness by considering three components of readiness: economic, governance, and social. Here, the Kyrgyz Republic ranks much lower at 104 of 191 countries, falling in the middle of its comparators.115
Distance to Markets The Kyrgyz Republic is a landlocked country, which presents unique challenges for trade and market access. Landlocked countries tend to have higher transport costs for their international trade and market access is dependent on maintaining cooperative relationships with their neighbors. However, to its benefit and unlike some other landlocked countries, it shares borders with relatively large markets, including China, Kazakhstan, and Uzbekistan, and has customs-free access to the Russian market through the Eurasian Economic Union.
115 ND-GAIN (Notre Dame Global Adaptation Initiative). https://gain.nd.edu/our-work/country-index/rankings/
123
Figure 9.7. Trade Intensity of Kyrgyz Republic and Comparators
The Kyrgyz Republic appears to be coping relatively well with its geographic situation. Despite the export and import distances and costs noted in the infrastructure chapter, relative to its comparators, it is a fairly trade-intensive economy. Total trade equaled 102 percent of GDP in 2017 and has exceeded 100 percent since 2006. Together with Armenia and Georgia, it sits in the upper tier of its comparators.116 Except for Georgia, all of the comparators in this diagnostic are also landlocked countries; that the Kyrgyz Republic appears to be more trade-oriented than many of them it implies that landlockedness is not a binding constraint for growth in its particular case.
Conclusion The Kyrgyz Republic is endowed with significant natural resources which have the potential to make even greater contributions to its economy. The country does not appear to face systemic problems in market access despite being landlocked. Though the Kyrgyz Republic has limited agricultural land due to its mountainous geography, this same geography benefits the country through its provision of abundant water, mineral resources, grazing lands, and unique biodiversity. Ultimately, the country does not have serious growth problems resulting from its natural capital endowment—instead, the binding constraint limits considerable opportunities to leverage this natural capital endowment for inclusive growth.
116 World Bank Group, World Development Indicators.
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